We see a meaningful possibility that today's Fed announcement will be a non-event, with the spread of the Delta Variant offering a reason for the FOMC to postpone more serious tapering communication until Jackson Hole. If anything, the balance of risks for the dollar appears tilted to the upside, also thanks to the China-related risk-off environment.
USD: Fed unlikely to rock markets
Investors' focus has been primarily on China over the first half of the week and on the sharp drop in Chinese equities which has created a shockwave that has hit most global risk assets. Asian sessions are seeing stocks still under pressure today, as we continue to se the negative impact of Beijing’s regulatory crackdown and a mixed response from investors to generally good earnings by US big techs.
The Fed rate announcement (at 1900 BST) will be the highlight of the day. As discussed in our FOMC preview, we see a non-negligible risk that the meeting will be a non-event. After all, Chair Powell has recently reiterated his view that inflation spikes have a transitory nature, and do not warrant any imminent change in the Fed’s policy mix. Indeed, markets will be highly sensitive to any comment about the timing and pace of asset purchase reductions, but the spread of the Delta Variant may have provided a good reason to remain cautious and to postpone any important tapering announcement to the Jackson Hole Symposium in late August. Our economist’s view remains that inflationary pressures will ultimately prove more persistent than what the Fed is forecasting and that there is an increasing risk that the Fed’s first hike will come already in 2022.
From an FX perspective, we suspect that the impact on the dollar from today’s announcement will be contained, with a balance of risks that appear tilted to the upside as the acknowledgment of above-trend inflation and growth should allow markets to keep speculating of a more hawkish turn in Jackson Hole, and on a 2022 rate hike. Despite falling real rates have put a cap on the dollar this week, an environment where investors continue to cast doubts over the flawlessness of the global recovery is supportive of the dollar.
EUR: Strictly range-bound
EUR/USD has continued to gravitate around the 1.1800 level, still looking unable to make a decisive move as the dollar remains protected from falling US real rates thanks to its safe-haven status and the euro appears to be lacking clear catalysts at the moment. Yesterday, comments by ECB’s De Cos fell firmly on the dovish side (not a big surprise, as De Cos is a dove), suggesting the ECB should maintain some flexibility on the shape of its QE program even after the pandemic. Today, there are no data releases worth mentioning in the eurozone, and some positive impact on the dollar after the rating announcement may send EUR/USD back to the lower region of its recent trading range.
GBP: Surprisingly good momentum
Sterling is the best performing G10 currency so far this week, as it detached from global risk appetite dynamics and may have been buoyed by a slowdown in UK Covid-19 cases, which is raising hopes that the government’s decision to lift almost all restrictions may prove to be a sustainable approach. Indeed, GBP is heading into next week’s Bank of England meeting with a balanced positioning, which may be allowing some hawkish speculation to emerge. EUR/GBP may test the 0.8500 psychological support already today, although there aren’t any market-moving data in the UK or in the eurozone.
AUD: Muted reaction to CPI spike signals low bets on RBA hawkishness
A slightly above-consensus surge to 3.8% in Australian headline inflation has had no impact on Aussie bonds and AUD. This is signaling how markets remain quite reluctant to price in any RBA hawkishness, although the generalized risk-off mood and concerns about China are likely playing a role in curbing AUD gains at the moment. We agree that the RBA will likely want to see more evidence that the economy is overheating (focus will remain on jobs data) before making any changes and that any rate hike is a way off, but it must also be noted that the Aussie dollar is the only G10 commodity currency that is combining a net-short positioning with a rate market that is pricing very little hawkishness of its central bank. For now, AUD's high exposure to China-related sentiment may keep the currency on the back foot.
Read the original analysis: FX daily: Rain check
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