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A Market Rethink on Fed's Dovish Ambition Sinks the Dollar

A Market Rethink on Fed's Dovish Ambition Sinks the Dollar

The USD was sold off today as the market took Fed's Williams comments by heart, even if he later tried to play them down by saying today's speech was not about potential policy actions to be conducted this month. Judging by the CME Fedwatch pricing of a 50bp rate cut, the market verdict still seems to suggest the conviction for an aggressive Fed cut is on the rise.

The Daily Edge is authored by Ivan Delgado, Market Insights Commentator at Global Prime. The purpose of this content is to provide an assessment of the market conditions. The report takes an in-depth look of market dynamics, factoring in fundamentals, technicals, inter-market in order to determine daily biases and assist one’s decisions on a regular basis. Feel free to follow Ivan on Twitter & Youtube.

Quick Take

Thursday's price action was characterized by a USD-centric selloff across the board after Fed’s Vice-Chair and NY Fed President Williams intensified his dovish rhetoric right before the Fed goes dark until the FOMC on July 31st. The market took his comments by heart, even if he later tried to play them down by saying today's speech was not about potential policy actions to be conducted this month, and while the USD recouped a significant portion of its US-led losses, judging by the CME Fedwatch pricing of a 50bp rate cut, last at 48% from as high as 71% a few hours later (yesterday stood at 32%), the market verdict still seems to suggest the conviction for an aggressive Fed cut is on the rise. The Euro was also knocked down against its main peers, as a report made the rounds that, in an unprecedented move, the ECB may be considering to revise its inflation goal mandate, in a sign that the Central Bank may have to resort to more stimulus for longer amid the puzzling phenomenon of low global inflation. On the flip side, the Sterling finally celebrated a positive day, and it wasn't just a mere gain, but the largest posted in the month of July, as the UK parliament passed the Benn amendment that will block a Sept-Oct parliament shutdown in case the new UK PM had the perilous audacity of strategizing with a hard-Brexit by running out of time. The Kiwi and the Aussie, the latter boosted by the reassurance provided by today's Aus jobs that the RBA will stay pat for a few months on rates, put on another solid performance. The same cannot be said about the Canadian Dollar, suffering an imbalance of supply as the market plays the divergence trade against intermarket flows as warned in yesterday's report. Lastly, both the Yen and the Swissy trod water once again by trading generally flat from an equally-weighted performance view, hence capitalizing only against the weakest (EUR, USD, CAD).

Narratives In Financial Markets

* The Information is gathered after scanning top publications including the FT, WSJ, Reuters, Bloomberg, ForexLive, Institutional Bank Research reports.

Fed's Williams goes beyond previous dovish remarks: Fed’s Vice-Chair and NY Fed President Williams made some clear dovish comments on Thursday, very consistent with the message carried by Fed’s Chair Powell and other Fed speakers during the month of July. The comments have shifted the focus back towards a more aggressive easing of 50bp in July, with the USD plummeting as a result. The sharp markdown in the US Dollar is predicated on the basis that today’s remarks were even more dovish than his prior comments on July 11th, and the fact that he made it right before what’s referred to as the dark period, which takes effect from Friday at the end of NY trading until July 31st, hence the comments one would think were intended to clearly send a message of where the Fed stands.

This is what Fed's Williams shared in today's speech: The policymaker said “it is better to take a preventative approach than to wait for disaster”, reminiscence of Powell’s word code “an ounce of prevention is worth a pound of cure” in the last FOMC. Williams reinforced his dovishness by noting “research shows that when neutral rates are low you should not keep your powder dry”, adding that “long-term forces lowering neutral rates set to linger.” Williams currently estimates neutral rates in the US to be around 0.5% and that inflation expectations are far more anchored these days (dovish). The headlines have cemented the case for the Fed to cut its interest rate by 50bp this month, as reflected by the whopping 71% chance assigned by the CME Fedwatch tool. Note: New York Fed Williams later on the day added his speech was not about potential policy actions at the July FOMC meeting, which has sent the USD back up again, recouping part of its losses.

Fed's Clarida joins the Fed's dovish party: If not sufficient evidence of the consistent easing message projected by Fed members since the last FOMC, today’s intervention by Federal Reserve Vice Chairman Richard Clarida should make it blatantly obvious as the policymaker outlined that the US economy is in a good place but uncertainties that may influence the US growth have increased, adding that global data is disappointing and inflation soft. Again, these are the exact same risks identified by Powell and other members to justify a preventive adjustment of rates lower. Clarida also hinted that since monetary policy operates with a lag, risks must be accounted for before data turns (too late).

Moment of reckoning for the ECB inflation mandate? In a report carried by Bloomberg, it was revealed that the ECB is considering to study a potential revamp of its inflation goal framework, with some of the ECB staff seemingly critics of the 'below, but close to 2%' definition as part of the mandate in what’s still a confidential and preliminary work. The immediate reaction by the market was to mark down the Euro as a school of thought is that by potentially being laxer on the doctrine that surrounds the mythical 2% inflation goal, the Central Bank makes the admission to potentially pursue longer stimulus programs based on the acceptance of lower inflation projections. The post-crisis era has proven to defy old established theories such as the Philip curve, with the preponderance of evidence proving that the relationship between unemployment and inflation is an obsolete approach to influence policy. Interestingly, the Fed has also recognized in the last few weeks the risk of low inflation for longer and its willingness to accept this reality, in what appears to be a coordinated effort to re-evaluate and adjust inflation targets in accordance with the new paradigms, which for now is seen as the recognition that in a world of ultra-low inflation, accommodative policies should be dominant with a much lower USD a tool the Fed may utilize to re-activate the reflationary environment through higher commodity prices, friendlier credit conditions in EMs and the ability of USD-funded corporations to keep up its profitability levels elevated.

Concessions by the EU on Brexit an illusion: EU's chief Brexit negotiator Barnier, time and time again, reiterates that there will be no renegotiation of the Brexit withdrawal agreement, which narrows down the possible outcomes to either a no-deal Brexit, a general election or second referendum. The hard-line position on the Irish border by the contenders to the post of UK PM (Boris Johnson and Hunt) make the option of renegotiation with the EU dead in the water. Nonetheless, as a bona fide gesture that may be interpreted as a slight positive input, the door was left open should UK politicians have a rethink and consider an alternative arrangement for the Irish border.

UK retail sales an outlier but Brexit dominates: While UK economic data has turned largely into a sideshow fully eclipsed by the Brexit conundrum, today’s UK June retail sales at +1.0% vs -0.3% m/m expected is certainly an outlier fueling the GBP rally. Growth in non-food stores and second-hand goods led the upbeat print, while food stores and department store sales were, in contrast, the negative inputs. Do not expect the data to alter the outlook for the GBP nor the BoE to budge as Brexit is what matters.

Shutting down parliament won't fly: The positive buy-side flows in the Sterling today were mostly driven by the Benn amendment in the UK parliament, aimed to prevent a Sept-Oct parliament shutdown with a vote of 315-274. Even if the new UK PM were to suspend sessions in the parliament in Sept and Oct, members of the commons would still be required to attend, which would make any effort to strategize a no-deal Brexit due to running out of time a no go. At the margin, it was a GBP positive as it allows more room for the UK government to agree on a compromise, which may include a general election, second referendum or the least likely, a renegotiation of the existing deal.

RBA can afford to wait for further cuts: Today’s Australian Employment Change for the month of June passed the test even if the headline number missed expectations by coming at +0.5K vs +9.0K expected, with the unemployment rate unchanged at 5.2%. As one digs deeper into the details, full-time employment rose by 21.1K, part-time declined by -20.6K, and the participation rate came at 66.0%, a tad higher than the 65.9% expected. To brightens things up down under, Australia’s NAB quarterly business confidence survey for Q2 came at 6 vs -1 prior, while on the flip side, business conditions, which accounts for trade, sales, profitability, and employment, weakened further to +1. Since the Reserve Bank of Australia has defined the logic of its easing bias on the developments in the labor market, today’s data, on balance, should support the notion that the RBA can afford a degree of patience till considering further easing sometime in Q4.

BoK cuts rates as global easing carries on: In what should be seen as a symbolic move of the shift towards a global easing bias, today it was the time for the Bank of South Korea to slash the key rate to 1.50% from 1.75%, citing that economic developments have been worsening along with signs that the easing will continue.

Philly Fed sees snap back up: In terms of economic data in the North American session, the US June Philly Fed saw yet another solid print of +21.8 vs +5.0 expected, highest in 1 year, with new orders soaring to +18.9 vs +8.3 prior, as did the employment component at +30.0 vs +15.4 prior. US unemployment claims came flat and the CB leading index disappointed. Meanwhile, the ADP Canada June employment recorded strong gains too, at +30.4K vs -16.0K prior, even if the prior month data was revised sharply lower from -16.0K to -36.7K, which essentially puts the net for the last 2 months at -6.3k. A second-tier data unlikely to influence the BoC at this stage.

Oil faces further pressure, Iran opens door to renegotiate: The pendulum in Iran’s willingness to return to the negotiating table with the US has been swinging left and right without much congruence this week. However, today’s comments came right from the horse’s mouth. The Iranian President Rouhani said Iran is determined to leave the doors open to save the nuclear deal after a telephone call with France's Macron. Besides, the Iranian foreign minister, Mohammad Javad Zarif, on a visit to New York, offered a return to the nuclear deal accepting enhanced inspections of its nuclear programme in return for the permanent lifting of US sanctions, even if Trump has made it clear Iran must cease the enrichment of uranium enrichment and support for proxies and allies in the region. The price of Oil kept its ill-fated week by dropping over 3% as traders price in chances of a reconciliation.

Recent Economic Indicators & Events Ahead

Source: Forexfactory

A Dive Into The Charts (Tech, Funda, Intermarket)

EUR/USD: Offers Absorb Buy-Side Pressure At Confluence Of Resistances

GBP/USD: The Sterling Boosted By Mixture Of Brexit, Fed Headlines

USD/JPY: Successful Rotation Puts Sellers Firmly In Control 

AUD/USD: Breakout On High Volume After Fed's Williams

Important Footnotes

  • Risk model: The fact that financial markets have become so intertwined and dynamic makes it essential to stay constantly in tune with market conditions and adapt to new environments. This prop model will assist you to gauge the context that you are trading so that you can significantly reduce the downside risks. To understand the principles applied in the assessment of this model, refer to the tutorial How to Unpack Risk Sentiment Profiles
  • Cycles: Markets evolve in cycles followed by a period of distribution and/or accumulation. To understand the principles applied in the assessment of cycles, refer to the tutorial How To Read Market Structures In Forex
  • POC: It refers to the point of control. It represents the areas of most interest by trading volume and should act as walls of bids/offers that may result in price reversals. The volume profile analysis tracks trading activity over a specified time period at specified price levels. The study reveals the constant evolution of the market auction process. If you wish to find out more about the importance of the POC, refer to the tutorial How to Read Volume Profile Structures
  • Tick Volume: Price updates activity provides great insights into the actual buy or sell-side commitment to be engaged into a specific directional movement. Studies validate that price updates (tick volume) are highly correlated to actual traded volume, with the correlation being very high, when looking at hourly data. If you wish to find out more about the importance tick volume, refer to the tutorial on Why Is Tick Volume Important To Monitor?
  • Horizontal Support/Resistance: Unlike levels of dynamic support or resistance or more subjective measurements such as fibonacci retracements, pivot points, trendlines, or other forms of reactive areas, the horizontal lines of support and resistance are universal concepts used by the majority of market participants. It, therefore, makes the areas the most widely followed and relevant to monitor. The Ultimate Guide To Identify Areas Of High Interest In Any Market
  • Trendlines: Besides the horizontal lines, trendlines are helpful as a visual representation of the trend. The trendlines are drawn respecting a series of rules that determine the validation of a new cycle being created. Therefore, these trendline drawn in the chart hinge to a certain interpretation of market structures.
  • Correlations: Each forex pair has a series of highly correlated assets to assess valuations. This type of study is called inter-market analysis and it involves scoping out anomalies in the ever-evolving global interconnectivity between equities, bonds, currencies, and commodities. If you would like to understand more about this concept, refer to the tutorial How Divergence In Correlated Assets Can Help You Add An Edge.
  • Fundamentals: It’s important to highlight that the daily market outlook provided in this report is subject to the impact of the fundamental news. Any unexpected news may cause the price to behave erratically in the short term.
  • Projection Targets: The usefulness of the 100% projection resides in the symmetry and harmonic relationships of market cycles. By drawing a 100% projection, you can anticipate the area in the chart where some type of pause and potential reversals in price is likely to occur, due to 1. The side in control of the cycle takes profits 2. Counter-trend positions are added by contrarian players 3. These are price points where limit orders are set by market-makers. You can find out more by reading the tutorial on The Magical 100% Fibonacci Projection
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