Cautious optimism remains in the currency markets regarding the idea that the signs of the US losing growth momentum will force the Fed to tap the breaks on monetary tightening and prepare markets for an easing cycle. Easing Covid policy in China is also supportive for market sentiment as investors price in a rising Chinese demand for imports and a recovery of the air travel sector. If these stories continue to evolve in a benign way, commodity market and EM currency sector will likely see major capital inflows. The focus today is on Powell comments and US NFIB data.
Risk assets started this year quite well with both the stocks and bond markets rallying. Emerging markets saw an increased demand too amid rumors that the Fed will end policy tightening in the first quarter and move on to cut rates as early as the third quarter of this year, and also thanks to supportive policy measures in China. AUD saw major capital inflows thanks to the easing of the China ban on coal imports while news about a 20% increase in China oil import quotas underpinned oil prices yesterday.
The story with the Fed today will be supplemented with two new details: Powell’s remarks at Riksbank conference, as well as NFIB small business survey data. Watching near-term bonds and credit spread markets’ dovish reaction we can say that the market is increasingly betting on an early Fed withdrawal from the tightening cycle and rate cuts in Q3. A major shift in expectations would come if Powell would attempt to keep the market focus on inflation risks and the need to keep raising rates. In this case, we will see a rebound in Treasury yields, and the dollar will “soar”. If it will be clear from the comments that the Fed is indeed inclined to slow down the pace of tightening, or even foresees an early end, the reaction of the markets is likely to be limited – sellers will push the level of 103 on DXY, and the yield of 10-year bonds will head towards support at 3.5%.
In the NFIB report, the market will look for additional information on a slowdown of the US economy, which was already eloquently reported by the ISM report last Friday (fall of the headline index from 55 to 49.6 points, industrial orders by 1.8% YoY):
It will also be interesting to look at firms’ plans to increase prices, as well as new orders (two leading indicators of economic expansion and inflation). It is important to understand that Friday’s ISM report set the market to expect another CPI easing in December, so investors may now be inclined to reduce dollar positions ahead of the release of the report on Thursday.
Looking at the EURUSD chart, the pair is approaching the short-term resistance level (1.08) and will probably test it with a breakdout. If the market manages to gain a foothold above 1.08 or wander around the level without a significant decline, this can be seen as a signal of a continued rally towards 1.10 (medium-term support), where profit-taking from the rally from 1.05 is likely to take place, and there will also be an occasion for speculative bearish momentum on expectations of a pullback from the round level: