Market Briefing: US Fed In Focus

• Upbeat risk sentiment. Optimistic markets are pricing in a ‘soft’ landing and think central banks could soon morph from inflation fighters to growth supporters.

• Will the US Fed spoil the party? Another, smaller, rate hike by the Fed is expected. But in contrast to markets, we think the Fed looks to be in no hurry to turn around later this year.

• Strong start to 2023 for the AUD. A weaker USD has helped propel the AUD. A push back by the Fed could see the USD recovery some ground.

The positive run across markets has continued. US equities edged higher last week, bond yields ticked up, oil and industrial metals prices are near recent highs, and in FX the USD has remained on the backfoot, particularly against pro-cyclical currencies like the AUD. AUD is tracking near 0.71, levels last seen in August. The AUD’s positive momentum on the crosses has also continued.

China’s faster than predicted COVID reopening has been a factor boosting risk sentiment. Also at play has been a run of better than anticipated data which has supported hopes the US and other major economies may undergo a ‘soft’ landing, that central banks have managed to slay the inflation dragon without causing too much economic pain, and that policymakers could turn course and ease policy later this year. The sharp reversal in the market’s thinking about the evolution of US interest rates has weighed on the USD over recent months (see chart below).

This week’s US Fed, ECB and Bank of England policy meetings may test the markets’ optimism. Another round of rate rises is predicted, but the messaging about where things could go from here should be more important given the swings in the market’s view. The Fed announcement and Chair Powell’s press conference are the main events (Thursday morning AEDT).

While the Fed looks set to ‘downshift’ the pace of its rate rises to a more typical 25bp move, we think the underlying message could be focused on how this shouldn’t be viewed as a ‘pivot’, that there is more work to do, and importantly that rates may need to stay high for an extended period for the medicine to work. The Fed is a student of history and is wary of repeating the mistakes of the 1970’s when central banks declared victory and eased policy too quickly enabling inflation to come roaring back. We think a pushback by the Fed against the easing in financial conditions and idea that rates could be lowered later this year may ruffle a few market feathers, generating some volatility and providing short-term support for the beleaguered USD.

Global event radar: China PMI (31st Jan), US FOMC policy meeting/Fed Chair Powell speaks (2nd Feb), ECB policy meeting (3rd Feb), US employment report (4th Feb), US CPI (15th Feb).

AUD corner

The AUD has had the wind at its back over recent months, rising by ~15% from its mid-October low. To date, AUD/USD has risen by ~4.2% in January. This has been the strongest start to a year since 2017, and the AUD's 3rd best January in 20-years.

The reversal in the markets thinking around how high US interest rates could reach this cycle and the build up of H2 2023 rate cut expectations has been a key driver. This shift has weighed on the USD and loosened US financial conditions (i.e. equity markets higher, credit spreads tighter, bond yields and volatility lower). As it typically does the AUD has benefitted from the more positive risk environment (see chart below). These trends have been compounded by optimism around China’s reopening and last week’s hotter than predicted Q4 inflation data which saw RBA rate hike expectations nudge back up.

Will the AUD's run continue? In our view, near current levels the AUD looks to have discounted much of the positive news around China’s economic reawakening, while additional RBA rate rises in February and March should also be factored in. As such the outcome of the US Fed meeting (Thursday morning AEDT) is likely to be a major determinant of the AUD’s near-term performance. The Fed is expected to move again, with a smaller 25bp rate hike telegraphed. But where markets may be complacent, in our opinion, is around how long the Fed is looking to maintain very high/restrictive interest rate settings in order to get inflation sustainably back down to target. Based on how tethered markets are to the US policy outlook we believe a strong push back by the Fed on the rate cuts from mid-2023 view, particularly if it is backed up by solid US jobs and wages data throughout the week, could generate a wobble across buoyant risk assets, provide short-term support for the USD, and/or take some heat out of the AUD.

AUD event radar: China PMIs (31st Jan), US FOMC meeting/Fed Chair Powell speaks (2nd Feb), ECB policy meeting (3rd Feb), US employment report (4th Feb), RBA policy meeting (7th Feb), US CPI data (15th Feb), AU jobs data (16th Feb), RBA Gov. Lowe speaks (17th Feb), AU wages (22nd Feb), RBNZ policy meeting (22nd Feb).

AUD levels to watch (support / resistance): 0.6962, 0.7053 / 0.7172, 0.7220

SGD corner

It has been one-way traffic for USD/SGD since touching its cyclical peak (1.4492) in late-September. USD/SGD is on track to record its 4th straight monthly fall in January, its longest such run since 2017. The downturn in the USD as markets adjusted their outlook about how high the US Fed could lift interest rates and how long before the next policy easing cycle starts, signs Europe’s recession may not be a dire as many were fearing, and the supportive growth impulse for Asia generated by China’s COVID policy U-turn have driven the ~9.4% decline in USD/SGD.

Will USD/SGD’s relentless slide continue? In our view, there is scope for USD/SGD to pause for breath and it could stage a bit of a near-term recovery. The US Fed and ECB policy meetings are in focus this week, and while 25bp and 50bp rate hikes are widely expected, relatively ‘hawkish’ messages that lean against the markets current optimism that the battle against inflation has been won, downside growth risks have lessened, and that central banks could step in and cut interest rates later this year to boost activity may generate some renewed volatility and/or see the USD make up a little lost ground. SGD event radar: China PMI (31st Jan), US FOMC policy meeting/Fed Chair Powell speaks (2nd Feb), ECB policy meeting (3rd Feb), US employment report (4th Feb), RBA policy meeting (7th Feb), US CPI (15th Feb).

SGD levels to watch (support / resistance): 1.3009, 1.3054 / 1.3260, 1.3330

FX Moves

Peter Dragicevich Currency Strategist - APAC peter.dragicevich@corpay.com

Upcoming Events

MONDAY (30th January)

CNH Local Chinese Markets Re-Open After The Lunar New Year Holiday

TUESDAY (31st January)

JPY Industrial Production (Dec) (10:30am)

CNH Manufacturing & Services PMIs (Jan) (12:30pm)

USD IMF World Economic Outlook Update (12:30pm)

EUR GDP (Q4) (9pm)

WEDNESDAY (1st February)

USD Employment Cost Index (Q4) (12:30am)

AUD House Prices (Jan)

NZD Labour Market (Q4) (8:45am)

EUR CPI Inflation (Jan) (9pm)

THURSDAY (2nd February)

USD ADP Employment (Jan) (12:15am)

USD ISM Manufacturing (Jan) (2am)

USD JOLTS Job Openings (Dec) (2am)

USD FOMC Policy Meeting (6am)

USD Fed Chair Powell Speaks (from 6:30am)

AUD Building Approvals (Dec) (11:30am)

GBP Bank of England Policy Meeting (11pm)

FRIDAY (3rd February)

EUR ECB Policy Meeting (12:15am)

EUR ECB President Lagarde Speaks (from 12:45am)

AUD New Housing Finance (Dec) (11:30am)

SATURDAY (4th February)

USD Non-Farm Payrolls, Unemployment (Jan) (12:30am)

USD ISM Services (Jan) (2am)

*Note, all times/dates provided are AEDT