Market Brief: Traders stockpile dry powder as Fed decision looms

Currency markets are drifting into Tuesday with a wary, slightly defensive tone, caught between a thin data calendar, declining volumes, and the growing sense that policy divergences are about to reshape the global landscape. Treasury yields are a touch softer after yesterday’s curve-steepening move, equity futures are pointing marginally lower, and the dollar is trading sideways against all of its major counterparts as traders brace for tomorrow’s Federal Reserve decision.

This morning’s Job Openings and Labor Turnover release could provide critical insight on job market conditions. Unusually, the report—which will cover the entirety of September and October as opposed to a single survey week—is set to land ahead of the monthly non-farm payrolls report, offering a more complete and more current view on whether hiring has continued to soften. Alternative private-sector indicators from ADP, Indeed, and Revelio have shown a modest cooling in labour demand and an uptick in layoffs in recent months, but the jury is out on whether this represents a material slowdown.

Most participants expect Chair Powell to recite a slightly-hawkish and now-familiar refrain in tomorrow’s post-decision press conference: patience, data dependence, and caution in the face of lingering uncertainty. On the face of it, this seems sensible–the last five decisions have played out in a similar manner, and there’s little to suggest that financial conditions have tightened enough to justify an aggressive easing posture. But we think market positioning might be slightly overegged, and suspect Powell could surprise investors with a modestly-sharper emphasis on downside risks*.

Policy expectations are shifting upward across the advanced economies, threatening to put downward pressure on the US dollar. Swap markets—which had already anticipated tightening from the Bank of Japan and an eventual halt to the Bank of England’s easing cycle—are beginning to price in rate hikes from the Reserve Bank of Australia, Bank of Canada, and European Central Bank, making the Federal Reserve a relative outlier in its drive to ease policy.

Here in Canada, at least one major bank expects the policy-rate gap with the United States to narrow by roughly 150 basis points over the coming year. Although past experiments—in 2002 and again in 2010—show that such a divergence is not inconceivable, it would require considerable conviction for the Bank of Canada to tighten while the Federal Reserve is still easing. But any move in that direction would almost certainly trigger a sharp appreciation in the Canadian dollar. With implied volatility in the dollar-Canada pair running well below that of other major currencies over the last two years, we suspect markets are underestimating the potential for outsized moves.

But the risk of a hawkish reset in US rate expectations is rising. If the Trump administration’s challenge to the Fed’s independence begins to falter—whether through a Supreme Court ruling blocking the president’s bid to dismiss Lisa Cook, the appointment of a seasoned moderate such as Christopher Waller to succeed Jerome Powell, a decisive rollback of tariffs, or an early-year run of stronger-than-expected data—investors could quickly rein in easing bets and send the dollar sharply higher. The greenback has a long record of steamrolling consensus forecasts before the ink has even dried, and there is little reason to think this time will be any different.

Against this backdrop, we think currency market volatility looks too low, conviction too thin, and the balance of risks skewed toward more abrupt moves as the year winds down.

*Please note the nuance here. I'm not suggesting Powell is about to capitulate and become an outright dove, just that traders might be positioned for a more hawkish tone than that which actually emerges. Remember that in currency markets, everything is relative. They're like Game of Thrones that way.

Market Overview

Notes: DXY: Dollar index, ON: Overnight movement, DMA: Daily Moving Average, Pivot points are calculated on a one-month basis, 3-month and 10-year spreads are against USD, Implied V.: implied at-the-money option volatility

Economic Calendar

*Please note: several US data releases have been removed, pending confirmation of release schedules from official statistical agencies.