So far there have been no surprises – consolidation is the name of the game this morning before ‘helicopter’ Ben gets to his press conference. The G10 major currencies have essentially traded sideways ahead of today’s FOMC economic projections, statement and rate announcements. However, for the EUR it has been a far different story up until this point. It seems that the single-currency bulls have become somewhat immune to negative EUR factors, allowing the currency to bid right up until the Fed decision. If the Fed happens to ramp up ‘taper’ talk this afternoon, then these EUR bulls may be in for some pain. A deteriorating dollar yield advantage has been a major driver of this latest EUR rally.
Although core-EUR outright short positions were never really that large, net dollar long positions across the G10 stratosphere grew to historic records. Something had to give ahead of today’s potential watershed central bank meeting – hence, the mass position liquidation that had many investors not just bleeding, but hemorrhaging during last week's FX sessions. It seems that the traditional “top picking” inadequacies of the EUR/USD trader has only added to the single-currency’s latest rally and increase the length of time to unwind these trades. The EUR has rallied nearly +4% from last month's lows and it seems that the majority of speculators are sitting long EUR’s heading into the meet, and this despite Euro fundamentals not changing. So, if this market is to sit ‘long’ to trade the reaction, then the EUR’s genuine weak side looks to be its left or lower.
So, what will be the Fed’s decision? It seems that many are not looking for any significant changes to the QE3 program. They expect that the best opportunity to scale back the pace of asset buying (+$85b a month) may not come until later this year – perhaps during September’s German elections? Ben’s press conference is the key; the Fed has to deliver a clear and precise message for investors to chew on. Anything ‘murky’ that can be misinterpreted and the asset classes’ bloodletting will begin again. Helicopter Ben is expected to use the press to try to push back against early hike expectations, emphasizing that an eventual end to QE may take place well before the Fed begins to raise rates. Do not be surprised if the central bank has decided to leave the door ajar to tapering for a later meet – it is good at “kicking the can further down the road.” If so, the usual plethora of excuses should apply – the need for more time to assess the fiscal drag, and on the data-dependent nature of the decision.
A dovish FOMC would be bullish for risk assets and any emerging currency with little exposure to a Chinese growth slowdown. In this scenario, the market will be looking toward North America, and specifically at those economies that have strong trade links with the U.S. (CAD, MXN). The current long EUR speculators will like a dovish statement, as the single currency will be expected to move higher as the markets follow U.S. Treasury yields lower on dovish comments. The ravaged ‘down-under’ currencies (AUD and NZD) should get a temporary reprieve. However, investors should expect that any decent rally to be hastily capped as the market looks to improve the positional ‘average’ by again shorting those antipodean currencies. For USDJPY, the U.S. short-term rates seem to be a non-issue. Investors cannot accurately use them to accurately gauge their positioning. Expect the market to be playing more of the “percentage rule,” buying USD/JPY Abenomic dips. Next month's Japanese governmental elections will tell us if short yen is still the correct position.
In the U.K., and in his final vote as a member of the rate-setting MPC, the outgoing BoE governor King was again defeated in a push for more stimuli for the British economy. As expected, the June minutes of the BoE’s MPC meet revealed the usual results of a 6-3 vote for QE and 9-0 for unchanged rates earlier this morning. The surprise was the recorded discussion relating to further QE – “for some members the costs are higher than the benefits.” The market needs to watch carefully the cost/benefit analysis scenario; this could “morph into whether the BoE should maintain QE at +￡375b in the future.”
However, for the majority of the market the preference is to deal with one central bank at a time – next up the Fed!