Fed expects B/S normalization “relatively soon”, dollar crashes
- The FOMC kept its policy unchanged yesterday as was widely anticipated, while the statement accompanying the decision had very few changes compared to the previous. The only changes related to the inflation outlook and the timing of the balance sheet normalization. With regards to inflation, the Committee acknowledged that it is “running below 2%”, a downgrade from the previous description that it was “running somewhat below” 2%. This may be a signal that the Fed is somewhat more concerned with persistently sluggish inflation. However, officials still expect it to stabilize around 2% over the medium term.
- With regards to the balance sheet, the FOMC changed its language to signal that its reduction will begin “relatively soon” instead of “this year” as it was noted in the previous statement. Even though this may look like a hawkish upgrade, the dollar collapsed. This suggests to us that some market participants may have expected a direct reference to a B/S reduction announcement in September, or some may have even expected an announcement yesterday for the reduction to begin in September. In our view, “relatively soon” is not a direct reference to September, but rather leaves the Committee some maneuvering room, which may have disappointed some overly optimistic investors.
- As for the dollar, we maintain our view that it could remain on the back foot for a while, amid low expectations for another rate hike this year, soft economic data, and elevated uncertainty over whether Trump’s fiscal plans will be implemented at all. The probability for another hike this year is roughly 50% according to the Fed funds futures. We think that a material rebound in inflation and economic growth is needed for that probability to rise and help the greenback recover somewhat. In this respect, the preliminary estimate of GDP for Q2 due out tomorrow will be closely watched.
- EUR/USD rallied following the FOMC decision, breaking above the all-important barrier of 1.1710 (S1), which acted as the upper bound of the long-term sideways range that had been in place since January 2015. In our view, the clearing of that level combined with the fact that both the short-term and medium-term outlooks remain positive, opens the door for further advances. Even if the rate corrects lower on a possible increase in US durable goods rates today (see below), we expect the bulls to regain control soon and perhaps aim for the 1.1880 (R1) resistance.
- USD/JPY tumbled yesterday in the aftermath of the Fed meeting. The pair fell after it hit resistance near the 112.25 (R3) resistance zone to stop slightly above the key support of 110.60 (S1). In our view, the short-term outlook remains negative, but we stay mindful that a corrective rebound from near 110.60 (S1) may be on the cards before the bears decide to shoot again. The catalyst for such a rebound may be today’s US durable goods orders.
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Today’s highlights:
- During the European morning, we get lots Swedish economic indicators. The unemployment rate for June is expected to have risen notably, which may hurt SEK somewhat. We also get the consumer and manufacturing confidence indices for July, but neither of these is usually a major market mover. In Eurozone, the M3 money supply for June is due out.
- From the US, as we already noted, we get durable goods orders for June. The forecast is for both the headline and the core rates to have risen. The case for solid durable goods is supported by the nation’s ISM manufacturing PMI for June, the new orders sub-index of which rose notably, indicating accelerating growth in orders. Such durable goods prints may help the dollar to recover some of its latest losses, but given the negative sentiment currently surrounding the currency, any positive reaction may remain relatively short-lived. We also get initial jobless claims for the week ended July 21st.
EUR/USD
- Support: 1.1710 (S1), 1.1615 (S2), 1.1585 (S3)
- Resistance: 1.1880 (R1), 1.1980 (R2), 1.2110 (R3)
- Support: 110.60 (S1), 110.30 (S2), 109.90 (S3)
- Resistance: 111.30 (R1), 111.70 (R2), 112.25 (R3)