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Re-pricing June Fed meeting sends USD higher

Swissquote Bank

Risk appetite continues to fade from the markets as expectations for a US rate hike grow. Markets are exhibiting all the classic signs of a “taper tantrum”. The DXY climbed sharply to 95.28 from 94.68 on the back of the less dovish FOMC minutes. The USD short squeeze extended with markets on completely the wrong side of early tightening. The greenback was stronger against G10 and EM currencies, while commodity linked currencies saw the heaviest selling. The AUDUSD sell-off intensified as the pair fell sharply from 0.7296 to 0.7191 after failing to clear the 0.7300 psychological resistance. Should the outlook for a rate hike increase the AUD and ASX are the most exposed in the G10 as higher yields will also trigger a sell-off in commodities. The US yields curve steepened across the curve, with US 10 years rising 5bp to 1.86%, the highest level we have seen this month, as expectations for a June rate hike mature. The PBoC set CNY midpoint at 6.5531 - the lowest level against the USD in three months. Precious metals came under decent selling pressure. Gold fell 2% to $1254.97, preparing to challenge the 50d MA support. Asian regional equity indices were in the red, following the S&P 500 pullback, with the Shanghai composite as the lone gainer. Potentially the only thing holding up the market from a full blown rout is the news that polls are indicating solid lead for the “remain” vote in the upcoming UK referendum. GBP retained its bullish feel, with the GBPUSD recovering to 1.4590 after a marginal decline from 1.4606.

Japan’s March core machinery orders rose 5.5% m/m and 3.2% y/y against 0.5% and 0.8% expected, providing further evidence that economic data is not as dire as originally anticipated. The rise in US yields helped USDJPY rally to 110.26 from 108.72. Correlation between US/JP interest rate spreads and currency has reengaged as Japanese investors become risk-taking, yield seekers. GBPJPY consolidated recent gains around 160.87. For a short term trade we would play the Fed interest rate recovery and declining “Brexit” fears story through a long GBPJPY trade. Despite the weaker JPY and positive Japanese investor sentiment, the Nikkei was unable to rally. Elsewhere, in New Zealand, April job ads rose 1.7% m/m, 4.6% y/y, indicating a strong labor market, while the consumer confidence index fell from 120.0 to 116.2. In Australia, April total employment increased 10.8k, putting the unemployment rate at 5.7%, yet the solid read did little to improve AUD in the face of significant macro risks.

The less dovish FOMC April 26-27 minutes have markets re-pricing in the possibility of a rate hike on 6th June. Fed Fund futures are now pricing in a 35% probability of a 25bp move in June - a 5% increase in the last few days. The language of the FOMC minutes suggests that a steady recovery in growth, healthy labor markets and a pick-up in inflation (especially considering recent wage data) could trigger tightening. However, the minutes make it clear that a decision will be data-dependent and that the risk environment remains fragile. We remain confident that mixed data, combined with a weak external environment, will keep dovish Yellen sidelined in June.

Yann Quelenn, market analyst: The Fed’s April meeting minutes have shown that most members of the US central bank are ready to raise at the next meeting. The EUR/USD reacted sharply by declining to 1.1220 before consolidating. Surprisingly, the Fed is again taking a hawkish stance with financial markets practically ruling out a June hike. Before the minutes the likelihood of a June raise was estimated at 4%, now it is up to 32%.

On the back of this release, short-term Treasury yields have increased to a 2-month high to 0.89%. However, in contrast US stock markets ended almost flat as fears of a possible end to the free money era have increased. Nonetheless, we should remember that a raise will only be possible if the economy picks up. The markets which, up to now were firmly focussed on global conditions are now thoroughly scrutinising the true state of the domestic economy. Consumer spending, which is on the soft side will be closely monitored in particular. We feel that markets have overestimated any June action and that the dollar should continue to suffer in the run-up to the June meeting. We reload our bullish position on the EUR/USD.” ---

In the European session ECB minutes and UK retail sales will be released. In the US traders will see Chicago business outlook, as well as Philly fed and leading index. South Africa will hold policy decisions and Mexico's central bank will release meeting minutes.

Source: https://swissquote-fx.com/en/research-and-analysis/
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