It's the busiest earnings day of the season (30% of the Stoxx 600 reports this week), with the outcomes likely mixed. This morning's price action will be exciting, with the FOMC sounding a cautionary tone yesterday with regards to the overall health of the US economy. Any rebound on the dollar triggered by global growth fears could derail the recent outperformance in commodities and China-exposed equities.
For example, oil prices have been pillowed by the weaker dollar, so that could be one to watch, as the demand outlook has been clouded by a rebound in coronavirus infections in Asia and the US. The easing OPEC+ supply restrictions, combined with the return of some US production may test the resilience of market sentiment in the coming weeks.
As far as policy is concerned, the FOMC was very light on substance, and after the Fed made its cursory mark to market view of the current risk environment, policymakers opted to pass the baton on to September. One of the critical focal points heading into the FOMC was yield-curve control, but at least in the FOMC's eyes, the sense of urgency appears to have waned. It is far from sure that anything will be announced in September.
But don't panic, the Fed isn't buying into "the recovery." Clearly, they view June data as a "sweet spot," as the economy rebounded from sudden to a partial reopening, the US consumer reaction was primarily mechanical in nature and more likely of the pent-up variety. The real economy won't recover for a very, very long time, and the real damage has yet to show.
One got the impression that the Fed was waiting for the next fiscal stimulus package to see whether, and where, it needed to provide support. And of course, allow time for the bevy of Fed economic quants to dial in the final write-up of the framework review. That way, its next policy decision doesn't front-run and diminish the anticipated positive jolt the market might get from a review.
Forex Markets
My thoughts in forex are not about the dovish Fed, but more towards month-end flow and crowded positions, where FX market makers will likely oblige tending to pass the hot potato lower. Risk parity rules suggest parity algos will buy dollars into month-end because EU stock markets did better than the US, so funds need to reduce their euro hedges proportionately.
Not to mention most of my data readings today across several key cross-assets are a bit dovish and crowded, but all closely correlated. The worry into month-end rebalancing is if one gives, all of them are liable to buckle.
We are heading into the month-end end, so given the reasonable guess would be that USD rallies and then reverses next week on a dovish FOMC. A V-shaped recovery for euro, if you will.
Ultimately when the Fed is in an easing cycle, market reaction to Fed meetings tends to be on the dovish side, even when the market goes in with dovish expectations. The Fed knows how to target financial conditions! Trust me on this one, there are some pretty crafty veterans on this crew.
Inflation targeting ?? Dream on
About the change in Fed policy to officially "run it hot," truthfully, I think we are in at the opposite end the credibility curve, like the BOJ in 2013 or so. Some folks think the Fed can control the inflation curve, the problem is we have about ten years, or more, of evidence to the contrary.
The Fed targeting higher inflation, when it can't get inflation above 2.0% in the first place could, like my trading colleague Randy (head of spot at a bank in Tokyo), target a golf score of 90, and coming in at his usual 110 and then moving the new target to 80. Just saying, Randy.