Change in Fed’s language was subtle but it did throw a bone to the doves; market still uncertain about QE tapering timeline

by Mike Jones

After dribbling lower for much of this week, this morning’s FOMC Statement has thrown the NZD/USD something of a lifeline. USD selling in the wake of the Statement has the kiwi back up and sniffing around the 0.8000 mark.

The change in the Fed’s language this morning was subtle, but it did throw a bone to the doves.

Clearer indications that the FOMC is concerned about rising US mortgage rates and low inflation have injected a bit more uncertainty into the market’s expectation QE tapering will kick-off in September. As a result, US bond yields and the USD have lost ground in the wake of the Statement.

In tandem with most of the major currencies, the NZD/USD has enjoyed a post-FOMC bounce, to the tune of around ½ cent.

No surprises for guessing the underperformer though. Yes, the AUD/USD remains firmly on the defensive, weighed down by speculative selling and rising rate cut expectations.

Notably, our NAB colleagues yesterday revised their RBA view to expecting two 25bps rate cuts by year-end, with another possible in 2014 (which would take the cash rate below 2.25%).

With the AUD/USD sliding below 0.9000 for the first time since 2010, the NZD/AUD has been propelled to within a whisker of 0.8900. Our valuation model suggests that the NZD/AUD is now “expensive’’ on the basis of short-term fundamentals. It estimates a short-term ‘’fair value’’ range of 0.8400-0.8600. However, this doesn’t mean a correction is likely.

Indeed, periods of NZD/AUD overvaluation often take time to ‘’correct’’, with pull-backs towards fair value usually presaged by a weakening in the fundamentals. We don’t think this is about to happen.

The AUD is unlikely to get any respite from today’s Aussie data. A deterioration in the terms of trade is expected from Q2 import and export price indices (due 1:30pm NZT).

Still, more important will be the Chinese PMI for July due at 1pm. With a weak number expected, and positioning in the AUD and NZD still short, a stronger number would pose the biggest risk to the antipodeans. The market expects a PMI of 49.8, with a result north of 50.5 probably needed to spur material gains in AUD/USD and NZD/USD.

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Majors

Though volatility has risen, most of the major currencies are little changed on net in the wash up from this week’s first round of top-tier event risk.

US bond yields and the USD climbed early in the night as US data impressed. An above-expectations 200k gain in ADP employment bolstered expectations of a solid result from Friday’s payrolls. And US GDP figures revealed a surprise acceleration in Q2 growth, albeit with some nagging concerns about a slowing in consumption growth (GDP 1.7% vs. 1.0% expected, consumption 1.8%y/y from 2.3% in Q1).

However, the greenback gave back most of its early gains in the run-in to, and in the wake of, this morning’s FOMC Statement. USD selling related to month-end portfolio rebalancing has also been a feature of the offshore session.

Overall, we don’t think there was anything in the FOMC Statement to keep the Fed from starting to taper asset purchases in September. However, the Statement did play up the hurdles the US economy will need to negotiate for the Fed to actually pull the trigger. In particular, concerns about the recent rise in US mortgage rates and persistently low inflation were noted explicitly for the first time.

As a result, the market reaction has been consistent with slightly more dovish turn from Bernanke and company. US 10-year yields have fallen around 5bps from pre-FOMC levels and, at 2.6%, are about 10bps below the night’s highs.

Consistent with the flattening in the US curve, investors have leaned on the USD. As a result, the EUR/USD looks to have finally broken through resistance at 1.3300 (currently 1.3320). GBP/USD has bounced from 1.5160 to 1.5240 and USD/JPY has slipped from 98.30 to 97.70.

For today, the dovish turn from the FOMC looks set to keep the USD a little heavy. However, we don’t think this morning’s Statement is a game changer for the greenback. The Fed has always said tapering is data dependent. And with this in mind we suspect all will be forgiven if we get a payrolls result of 200k or above on Friday (which now looks to be the risk following last night’s ADP figures).

Certainly, payrolls will be the next big market moving event, with tonight’s Bank of England and ECB meetings unlikely to ruffle too many feathers. No change in policy is expected from either, with the latter likely to sound a little more upbeat following the recent improvement in European data.

Event Calendar:

1 August: CH manufacturing PMI; CH HSBC manufacturing PMI; AU new home sales; EU manufacturing PMIs; UK BoE meeting; EU ECB meeting; US ISM manufacturing;

2 August: US non-farm payrolls; US factory orders; US Fed’s Bullard speaks.

All its research is available here.