Ahead of the FOMC meeting

For the past few weeks, the market has been quite vulnerable: equities (S&P 500) are down more than 4% since September’s high of 2,019.26 (Sep 19th) and approaching the July/August drawdown (4.35% correction), US LT yields are still compressed with the 10-year trading at 2.35% this early afternoon (on its way to retest the 2.3030% low we saw back in August) and an overall US Dollar weakness since the beginning of the week, erasing its post-NFP gains. Tonight, the Fed will release its FOMC minutes (From September’s meeting) and analysts expect it to have a hawkish tone.

My view, as you may have read it in some of my previous posts, is that I expect US policymakers to step back a bit on their expectations of its ST monetary policy.

I heard and read that we switched to a Q2 rate hike now (instead of Q3), which could have explained the late Dollar strength we have seen. However, remember something: October is the Fed’s POMO – Permanent Open Market Operations – last month, and starting October 28th (first day of the next FOMC meeting), the equity bulls will start to rely on fundamentals only. Tonight, the tone will probably switch to neutral (vs. hawkish), therefore I don’t see any major moves on the market.

If we have a look at the carry trades, AUDJPY (black bars in the chart below) has been fluctuating within a 100-pip range [95 – 96] for the past couple of weeks and is now down 2% since its high of 97.90 on September 19th (which was also the S&P 500 September’s high). The pair looks under ‘pressure’ and we will see if the 95 level holds for now. A move below 94.80 would bring us to early August levels.

AUDJPY
(Source: Reuters)

Euro: I reached my 1.2500 target on EURUSD after Friday’s US employment report, and I am considering going short again above the 1.2700 level. The market was ‘kinda’ disappointed by Draghi’s conference last Thursday, but I still believe the single currency is capped on the topside against the greenback. The next resistance area on the pair stands at 1.2700 – 1.2750.

Despite EZ sovereign bonds trading at [almost] record low levels, fundamentals are still poor in the Euro Zone. In Spain, the government of NE Spanish region of Catalonia will decide by October 15 for the referendum on separation from the rest of the country. The housing sector in the country looks still vulnerable and the government budget deficit (one of the largest if the EZ, accounted for 7% of GDP in 2013) is on ‘its way’ to exceed the target set by its EU peers [another time]. Therefore, the lack of ‘discipline’ will add pressure on the government to imply more austerity, raising Catalonians’ anger.

Other data: Australia will report its jobs data overnight and will revise its August 121K report which the Bureau of Statistics (ABS) judges too good to be true. We could see some disappointment there, which could send AUD/USD down to Monday’s level (0.8700 to start).

The Bank of England meets tomorrow, but I expect it to be a non-event. However, I would like to express myself quickly of the late GBP moves we saw, with Sterling switching from a once-used-to-be market’s darling to the most vulnerable currency (even against the JPY). I think the market overreacted a bit on the late UK fundamentals, and many participants are pricing a rate hike in Q2 next year (vs Q1 previously). I still see the BoE as the first major CB to starting raising rate, and the recent sell-off makes me believe that it may be a good time to go long GBP (against EUR, JPY or AUD).

Bonus chart: After it peaked at 1.17% in mid-June, the implied rate of the Short Sterling March 2015 futures contract is now down 40bps, taking Cable with him.

sg2014100849735
(Source: Bloomberg)