Ahead of the Fed verdict. The tumble in Chinese stocks continues to add uncertainty to global equity markets ahead of today’s policy announcement from the Fed. Asian stocks extended their declines Wednesday while investors are concerned about the economic recovery given the spread of the Covid-19 delta variant (in the US, Europe and Asia). The Fed is not expected to present any big news today. The FOMC statement should reflect the continued impressive economic expansion (GDP data tomorrow), the elevated but still transitionary spike in inflation and well-anchored inflation expectations while highlighting downside risks from the virus, the fiscal headwind (see below) and production disruptions due to the current imbalances in the goods and labour markets. S&P 500 futures remain close to zero this morning (S&P 500 fell 0.5% on Tuesday). The yield on 10-year US Treasuries was at 1.24% and EUR/USD traded near 1.18.
Mixed price action in Asia FX as we head into FOMC tonight. Yuan reversed 1/3 of yesterday’s loss as equities sell-off taking a breather. Meanwhile, Korean won traded to the weakest level in 10months as South Korea reports record daily cases increase as well as a weaker consumer confidence data print. Our traders like to keep positions light here as markets digest risk-off while also noting month-end dollar selling signal highlighted by our quant team earlier.
Looking ahead, all eyes on FOMC: our Econ team’s base case remains unchanged since late 2020 for a Sept announcement and Dec start of tapering. It expects Fed to communicate significant details on the pace and composition of upcoming tapering - if anything it thinks officials will move further than markets expect.
USD and the Fed: All bark and no bite?
Ever since the Fed started talking about QE taper and brought forward the start of its tightening cycle to 2023 at its June policy meeting, the investors have been poring over recent speeches of FOMC members looking for indications that they have moved closer to policy normalization. By the looks of it, there still seems to be no consensus at the Fed on the need to reduce stimulus with influential policy makers like John Williams, Fed Vice-Chair Richard Clarida and the Fed Chair Jerome Powell himself suggesting that QE taper “is still a ways off”. Ahead of July FOMC meeting, the US inflation has accelerated further with the gains in the core print in particular raising questions about the temporary nature of the overshoot. Moreover, following a period of subdued labour market gains, the employment outlook in the US has started improving. Last but not least, while the recovery of the US economy has come off the boil in Q2 and at the start of Q3, it remained very strong historically. Recent interactions with clients have suggested that investors are expecting the Fed to stick with its patient approach. We therefore think that the bigger risk on the day would be a ‘hawkish surprise’ similar to the June policy meeting. Indeed, evidence that the recent economic data releases have started to shift the balance of risks at the FOMC in favour of policy normalization in coming months could encourage the front-loading of rate hike expectations and boost UST yields. The USD could regain some ground on back of growing rate and yields advantage. Depending on how resilient risk appetite is in the face of tightening US financial conditions, any USD gains would manifest themselves vs low-yielders like the JPY (under risk on) or risk-correlated currencies like the GBP (under risk off).