The start of what could be the most meaningful week remaining of this year has been one favouring haven assets. Although they were off their intraday lows when this report was written, stocks initially fell sharply with all the major US indices breaking below last week’s ranges. Meanwhile crude oil prices extended their post-OPEC drop amid growing supply concerns, while the likes of the Japanese yen, Swiss franc and gold all gained ground as the dollar sold off. Even the euro managed to push higher in the dollar’s slipstream as Donald Trump’s latest criticism of the Federal Reserve ahead of Wednesday’s FOMC rate decision weighed on the greenback. Overall, the markets continue to remain in a “risk on, risk off” environment – more of the latter and less so of the former – as market participants weigh the impact of slower economic growth against an outlook for slightly less tighter monetary conditions than was the case previously.
Dovish hike on the cards
The Fed’s rate decision is this week’s major risk event and it is almost safe to say that nothing else will matter. Obviously, something unexpected may come out which will make me eat my words, but as far as scheduled events are concerned, I just don’t think they will have any meaningful impact on the markets as much as the Fed’s meeting will likely have. Investors are expecting to see a dovish rate hike from the Fed – a rate rise, accompanied by a statement that provides an outlook for slower rate increases for the foreseeable future, compared to the central bank’s assessment in September.
Growth concerns mount
Part of the reason why the market is becoming convinced that the Fed will signal a pause in its hiking cycle is evidence of slower economic expansion in major trading partners of the US. The recent emerging market currency crises, trade tariffs and political uncertainties have been factors weighing on consumer and business spending. Investors are concerned that the weakness in foreign demand will hurt the US economy and discourage the Fed from raising rates further.
Trump surprised Fed “is even considering” raising rates
Also weighing on interest rate expectations is, US President Donald Trump’s persistent criticism of the Federal Reserve. Mr Trump is surprised that the US central bank “is even considering” raising interest rates again this week. In a tweet, he said: “It is incredible that with a very strong dollar and virtually no inflation, the outside world blowing up around us, Paris is burning and China way down, the Fed is even considering yet another interest rate hike. Take the Victory!” Interestingly, Mr Trump apparently only becomes vocal about the Fed rate hikes during times of stock market turmoil.
EUR/USD 1.15 on the cards?
With the ECB meeting out of the way, the EUR/USD is still holding above that long-term 1.13 support level (see the monthly in the inset) despite the central bank sounding overall more dovish than expected last week. Thus, if the Fed now turns out to be also more dovish than expected, then the EUR/USD exchange rate could spike higher. In fact, looking at the yield difference between US and German 10-year government debt, the risks are skewed to the upside. This yield spread has been putting in short-term higher highs, in favour of German yields. Given the historical relationship between the EUR/USD and the yield spread, the positive divergence we are seeing here does indeed suggest that the exchange rate has some catching up to do. Thus, we expect the EUR/USD to break higher in the coming days. We would be wrong, however, if the EUR/USD were to close decisively below 1.1300.
Source: TradingView and FOREX.com.