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Fed Preview - How to Trade Yellen's Credibility Problem

  • Kathy Lien
  • 14 June 2017

Daily FX Market Roundup 06.13.17

By Kathy Lien, Managing Director of FX Strategy for BK Asset Management

 

On the eve of the Federal Reserve's quarterly monetary policy announcement, no one is buying U.S. dollars.The greenback ended the day lower against the Japanese Yen, Sterling, Canadian and New Zealand dollars and was unchanged versus other major currencies.  Even the strongest rise in annualized core producer price growth did not spark lasting demand as investors eye the rate decision with caution. The problem is that everyone expects the Federal Reserve to raise interest rates by 25bp on Wednesday so the rate change will be the least interesting part of tomorrow's monetary policy decision.  Instead investors will be focused on the dot plot, changes to the central bank's economic projections, the tone of Yellen's speech and their plans to reduce the balance sheet.  There's significant debate on how the Fed approaches each of these issues so fireworks are expected.  The dollar, which has been trading quietly versus the yen and euro ahead of the decision, will most likely break out of its 1.1165-1.1285 EUR/USD and 109.50-110.50 USD/JPY range.

As we look to the rate decision, here are the 3 main questions for the Fed tomorrow:

 

1.     Will the dot plot still show 1 more hike in 2017?

2.     Will the Fed provide details on how it plans to reduce its $4.5 trillion balance sheet?

3.     Will Janet Yellen stand firm on her view that stronger labor market conditions will take inflation back to target

 

If the answer is YES to all of these questions, the dollar will rise, otherwise, it's a sell on rally.

This month's FOMC rate decision is about credibility. The following table shows more improvement than deterioration in the U.S. economy since the last meeting but none of us can forget the big disappointment in non-farm payrolls this month. Economists were looking for 185K jobs and only 135K jobs were created.  This follows a downward revision the previous month and a staggeringly weak 50K increase in March.   The economy is not performing as well as the Fed has hoped and there's no clear timeframe on tax cuts or fiscal stimulus.  The political drama in Washington is stifling progress on economic stimulus.  To forgo raising interest rates would be major credibility issue for the Fed because U.S. policymakers have taken every opportunity to say that 1 to 2 more rate hikes are needed this year.  Unfortunately their credibility will remain in question if they tighten because weak data leaves the Fed stuck between a rock and a hard place.  Thankfully time is on their side with investors not looking for a follow up move until December. 

With 6 months before the December meeting, we think it is too soon for policymakers to drop their call for one more hike in 2017. Their credibility would take a major hit if they shifted guidance and then changed shortly thereafter as data improves. So while we expect Yellen to recognize the down drift in inflation and softness in data she will also provide details on reducing the balance sheet.  If her tone was cautious back in March, its only going to become more so in June and that's why we believe that unless she is overwhelmingly hawkish, keeping the door open to another hike in September, the rally in the dollar should be sold.

 

 

Meanwhile positive political and economic developments sent sterling higher against all of the major currencies.  There's talk of a coalition agreement between the DUP and Conservatives. Consumer prices grew at its strongest pace in 4 years with core consumer price growth hitting its highest level since 2012. This increase was a surprise powerful enough to driver short covering in sterling.  We still think GBP is a sell on rallies with the latest recovery mimicking the move in 2010 when GBP/USD rebounded off its post election lows only to break the low by 250 pips after a Coalition government was announced. With that in mind, U.K. labor data is scheduled for release tomorrow and stronger job growth is expected as the manufacturing sector saw its greatest improvement in jobs in 3 years according to the PMIs. We like selling GBP/USD between 1.2790 and 1.2830 though EUR/GBP would be a better trade as there is no embedded USD/FOMC risk.  

The best performing currency today was the Canadian dollar, which extended its gains on the back of Bank of Governor Poloz's comments. Although he was not as explicit as Wilkins who questioned the bank's easy monetary policy, Poloz said interest rates have been extraordinarily low and have done their job.  Combined with the rise in oil prices, his comments took USD/CAD within 10 pips of 1.32.  The break of the 50 and 100-week SMA means that further losses are likely with a possible drop down to 1.3050.  The New Zealand dollar also pressed higher but lower business confidence prevented the Australian dollar from participating in the rally. 

 

The euro also ended the day unchanged against the greenback.Although investors grew less optimistic about Germany's economic outlook, they felt better about current conditions in the Eurozone's largest economy and the outlook for the Eurozone in general.  For this reason we continue to expect EURO to outperform the GBP.  EUR/USD will also be a good trade if the Fed disappoints.    

 

 

 

For more information, they can be reached at http://www.bkforex.com/.

 

The information, including Commentary and Trade Ideas, provided on BKAssetManagement.com should not be relied upon as a substitute for extensive independent research which should be performed before making your investment decisions. BKForex Advisors LLC and BKAssetManagement.com are merely providing this information for your general information. The information and opinions presented do not take into account any particular individual's investment objectives, financial situation, or needs. All investors should obtain advice based on their unique situation before making any investment decision and should tailor the trade size and leverage of their trading to their personal risk appetite.

BKForex Advisors LLC will not be responsible for any losses incurred on investments made by readers and clients as a result of any information contained on BKForex Advisors LLC. BKForex Advisors LLC do not render investment, legal, accounting, tax, or other professional advice. If investment, legal, tax, or other expert assistance is required, the services of a competent professional should be sought. 


About the Author
Kathy Lien
Kathy Lien is Managing Director and Founding Partner of BKForex. Having graduated New York University’s Stern School of Business at the age of 18, Ms. Kathy Lien has more than 13 years of experience in the financial markets with a specific focus on currencies

Ms. Kathy Lien is Managing Director of FX Strategy for BK Asset Management and Co-Founder of BKForex.com. Her career started at JPMorgan Chase where she worked on the interbank FX trading desk making markets in foreign exchange and later in the cross markets proprietary trading group where she traded FX spot, options, interest rate derivatives, bonds, equities, and futures.

In 2003, Kathy joined FXCM and started DailyFX.com, a leading online foreign exchange research portal. As Chief Strategist, she managed a team of analysts dedicated to providing research and commentary on the foreign exchange market.

In 2008, Kathy joined Global Futures & Forex Ltd as Director of Currency Research where she provided research and analysis to clients and managed a global foreign exchange analysis team. As an expert on G20 currencies, Kathy is often quoted in the Wall Street Journal, Reuters, Bloomberg, Marketwatch, Associated Press, AAP, UK Telegraph, Sydney Morning Herald and other leading news publications.

She also appears regularly on CNBC’s US, Asia and Europe and on Sky Business. Kathy is an internationally published author of the bestselling book Day Trading and Swing Trading the Currency Market as well as The Little Book of Currency Trading and Millionaire Traders: How Everyday People Beat Wall Street at its Own Game all published through Wiley. Kathy’s extensive experience in developing trading strategies using cross markets analysis and her edge in predicting economic surprises serve key components of BK’s analytic techniques.


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