The Market Positions For A Dovish Rate Hike In Today’s FOMC
In the last 24h, the intensity of the US Dollar sell-off gathered further steam. This dynamic clearly indicates that the market is not placing too high its hopes. The behavior in the US Dollar leading up to today’s event communicates the market is betting for an uber-dovish rate hike. In other words, the FOMC may still raise its interest rate one more time, although it will probably set the bar much higher to keep the tightening campaign going.
If they opt for the dovish hike, it won’t necessarily look like a Central Bank compromised by the recent tweets of Trump, but rather, acting in a way that helps to ease the further tightening of financial conditions, a dynamic that has only worsened via higher funding costs/lower liquidity in the system. The flattening of the US yield curve also communicates the Central Bank is getting ahead of itself. These developments disincentivize the Fed to keep its aggressive rate hike rhetoric, so they’d be less compelled and keep the powder dry, even if they will continue to highlight, especially via such a pragmatist as Fed’ Powell is, that the Central Bank will remain data-dependent.
One of the most pressing issues to address in today’s FOMC meeting includes the update of the dot plot rate forecasts, as well as potential upcoming revisions to the Fed’s balance sheet normalization process.
The only way to explain the changes in option premiums heading into the event is by accepting as true that the market’s view — as a hint — is that expectations for rate hikes heading into 2019 may be nullified as the eurodollar futures market or the US yield curve indicate. Similarly, we might see a Fed shifting the narrative towards an adjustment in its balance sheet normalization process too. Only under these dovish circumstances or similar in USD downside impact I can justify the change in options pricing.
Let’s now get into the details. What I’ve learned from today’s cross-asset analysis, judging by the variations in the pricing of options, is that the consensual view via US treasuries and equities substantiates the notion that the Fed may be working to engineer some type of circuit breaker in the soulless stock market. Even if the pricing to own puts in the E-mini S&P 500 is still much more expensive, the major reduction in premium cannot be ignored and tells us that the market is less bearish in equities heading into the event.
Just as it cannot be ignored the higher prices to own calls in US treasuries, jumping by over 100% from its previous 25-delta RRs. Throw into the mix the decrease of over 0.5bp in 25-delta risk reversals in the USD/JPY, and it looks like the US Dollar is poised to suffer further downside pressures. However, it may not be a broad-based move, as commodity currencies still remain largely unfavoured, not just in its spot technicals, but via the pricing of options.
That’s what options traders are telling us. They certainly have taken note, as bond traders did via the flattening of the US curve, that trade tensions, the fading of the fiscal ‘sugar rush’, the US twin deficits, weakness in the housing market, the slow down in investment growth, the late business cycle, Powell’s shift in narrative from a long way from neutral (October 3rd) to rates being “just below” estimates of neutral policy (November 28th), when compounded, place the risks of a more relaxed Fed into 2019, outweighing the pros.
In today’s report, I’ve also noted additional downside protection bought — via OTM puts — in the EUR/USD this week. A market that I find personally very interesting to endorse in buy-side action if the view by options traders materializes is gold. Vol is going to pick up substantially, but some pairs such as the EUR/USD, AUD/USD, judging by its implied vol, may still be contained in wider yet familiar ranges. However, gold appears to be an exception, together with the EUR/JPY, amid low gamma-scalping requirements.
All in all, brace yourself for a wild ride, in what’s set to be one of the major events of the entire year. It will set into motion the stage to approach 2019 with from a point of greater clarity to diversify one’s portfolio.
US President Trump had another go at the Fed via Twitter, calling for the Central Bank to pause further interest rate hikes. He is interfering in the decision of an independent institution in a way that is unprecedented for a US President, in hopes of a circuit breaker for stocks. The tweet read: “I hope the people over at the Fed will read today’s Wall Street Journal Editorial before they make yet another mistake. Also, don’t let the market become any more illiquid than it already is. Stop with the 50 B’s. Feel the market, don’t just go by meaningless numbers. Good luck!”
Another day characterized by analogous dynamics in risk behavior, with follow-through selling in US equities and US bond yields, while the US Dollar keeps weakening ahead of the FOMC. The tendency to sell a macro expensive USD is, in a way, capping the potential downside the currency may suffer immediately after the Fed decision. Look for some potential upside spikes to find liquidity and if the Fed is indeed overly dovish, then would be time to engage in USD selling. On the contrary, if the Fed refrains from a dovish tilt, all hell may break loose for USD bears, especially on such aggressive pricing of a dovish outcome this week.
Relatively good news out of the Eurozone as the European Economic Commission, via its representative Mr. Moscovici, confirmed that France is not going to be sanctioned over its budget deficit on the basis that the country’s breach is ‘temporary, limited and exceptional’. Similarly, an Italian government source has announced that the EU commision has, at last, accepted the 2019 budget deficit of 2.04%. These 2 developments are clear positive inputs for the Euro, even if no effect in the price today.
Oil got absolutely whacked by falling over 7% as concerns about oversupply and global demand slowdown continue to mount. The sharp decline asserts the view that heading into 2019, the risk of inflationary pressures should remain largely capped by energy prices.
Chinese President Xi, in a speech on the 40th anniversary of Deng’s market opening and reform, refrained from sounding retaliatory, even if he indirectly hinted that the US is in no position to dictate the future of China. The 90-day trade truce goes on, despite the market seems to have moved on, with the worries having morphed into a concerted global slowdown. The massive decline in Oil is definitely an indication of such concerns.
The UK is accelerating preparations in case of a no-deal with the EU. The Cabinet has agreed to set into motion the remaining elements of the no deal preparation. Time is running out for the UK, and these type of headline won’t help the Sterling. At this juncture, both technical and fundamentals are alienated for further downside pressure in GBP/USD.
The ANZ business confidence in NZ rose 13 points in December, printing the highest in 8 months, while firms’ views of their own activity lifted 6 points. The official reports via ANZ could read that “expected profitability and employment, investment and export intentions rose, and perceived availability of credit jumped sharply. On the downside, marring the picture a little, most indicators for the agriculture sector deteriorated.”
The RBA minutes erred on the side of caution, with a narrative that could be considered a tad more dovish, on the basis of less optimism around the Aussie economy. There was more attention than usual given to credit, housing, consumer and external risks.
The German Dec IFO business climate index, which is perceived as one of the top leading indicators for the overall health of the German economy, came at 101.00 vs 101.7. It was the lowest reading since Sept 2016 and the data is yet another element that will undermine the ability of the ECB to turn more hawkish into 2019. The risks keep mounting for the ECB to stay on the sidelines, refraining from any tightening campaign next year.
Building permits and housing starts in the US saw a recovery in Nov. However, as part of the reports, Single-family housing starts fell more than 13 percent last month from a year earlier.
In what should be regarded as a volatile series, the Canadian manufacturing sales undershot its expectations in October, following four increases in the previous five months.
The New Zealand GDT price auction printed a solid 1.7% with an average selling price of $2,844.00. It’s the second consecutive fortnight rise after a tough 6m losing streak.