The consensus view for the FOMC today may be a hold, with two dissenters voting for a . That might prevent a material downward correction in rates, but the dollar may still fall as precautionary positioning is unwound and the greenback reconnects with lower oil prices. This means might be past its lows
USD: Dollar to Reconnect With Lower Oil After Fed Hold
Our Fed preview, published last week, argued that precautionary positioning for a potential surprise Fed hike could keep the dollar supported going into today’s FOMC announcement. That appears to have been the case. Despite softer data and de-escalation headlines weighing on the dollar yesterday, has shown little sensitivity to the recent decline in oil prices.
But that resilience will be tested heavily today. Markets are pricing in 7bp, or about a 25-30% probability of a Fed hike today. That, in theory, implies a mechanical correction lower in front-end USD rates if – like we expect – rates are kept unchanged. That said, great attention will be on the vote split.
It seems to us that consensus expects two dissenters – Logan and Hammack – to vote for a hike. In that case, year-end rate expectations (41bp) may remain broadly supported, but we would still see downside risks for the dollar. The rationale links back to our first point. A Fed hold should trigger an unwinding of precautionary USD positioning, allowing the dollar to reconnect with the signal from lower oil prices. The resumption of military strikes in the Gulf overnight does not seem to be severely denting markets’ hopes for de-escalation, with remaining below US$90 a barrel for the moment.
In other words, unless Fed Chair Kevin Warsh surprises with a hawkish spin, or we see more than two dissenters, we think the dollar will come under pressure today. If constructive headlines from the Gulf return, we expect a test of 101.0 in DXY by the end of this week.
EUR: Looking Back to 1.15 Soon?
The resumption of military strikes overnight is a reminder that caution remains warranted on EUR/USD. Even so, if markets are right to maintain a broadly constructive view on further de-escalation, there is a good chance the pair bottomed out last week. For a sustainable move back above 1.15, two pieces are still missing: dovish Fed repricing, either through US data or communication, and a stabilisation in risk sentiment. While tech stocks’ independence from rates helped support EUR/USD during the spring, the current turmoil in the chip sector may now cap gains despite improving Middle East headlines.
With little on today’s eurozone calendar, EUR/USD should take its cue from the FOMC. As a baseline reaction to a modest dovish Fed surprise, we look for a move back into the 1.1400-1.1450 range over the coming days.
AUD: Surprisingly Soft CPI Data
Australian inflation came in softer than expected this morning. Headline slowed from 4.0% to 3.8% in June, equivalent to 0.6% QoQ, while the – Australia’s preferred core measure – held at 3.6% against expectations of 3.7%. The immediate market reaction has been significant: the two-year AUD swap rate has fallen 10bp, leaving AUD as the only G10 currency weaker against the USD today.
Markets have sharply pared back RBA tightening expectations, from around 20bp before the release to 13bp at the time of writing. While we also expect no further RBA hikes this year, the market response may be somewhat excessive. Higher energy prices in July suggest inflation data over the rest of the summer could prove less reassuring, and Governor Michele Bullock has continued to signal that additional tightening might still be required to return inflation to target.
In the near term, AUD remains challenged by volatility in Asian equities. However, our dovish Fed view, the more limited scope for further declines in front-end AUD rates, and AUD’s favourable carry and terms of trade keep the medium-term outlook constructive. We continue to target 0.73 in by December.
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