Central Bank issues weigh heavy
Today is the start of the two-day FOMC meeting which will provide a decision tomorrow on rates once the CPI and retail sales data has been released. A 25bp rate hike is fully priced-in so the focus will be on the FOMC policy path moving forward. With only 18bp of hike priced-in for the rest of 2017, there is plenty of room for a hawkish Fed to trigger the outsized bearish USD position race for the door.
Wage growth and inflation weakness are behind investors’ expectations for a shallow tightening cycle. However, it becomes difficult to forecast further mid-term USD weakness as the Fed quickly tightens policy through reduction of its massive balance sheet. Tomorrow’s hike has been dubbed a “dovish hike” and that works well for Janet Yellen. As the market is focused on interest rates, she can quietly tighten without excessive USD strengthening. We remain constructive on USD against low yielders like JPY and CHF.
Elsewhere, BOC Senior Deputy Governor Carolyn Wilkins speech provided a hawkish turn by highlighting the country’s solid economic improvement. The comment suggests the BoC has shifted marginally in monetary policy. The speech gave the underpriced CAD a strong push as short-end rate jumped, 50% probability of a 25bp hike in 2017. Other central banks are not expected to bring about many changes. The Swiss National Bank will remain cautious despite easing in political pressure from Europe. The SNB will keep their defensive CHF position through physical intervention and loose monetary policy via negative interest rates.
The Bank of Japan will possibly address mounting criticism of extreme policy strategy. The focus will be on the BoJ assessment of economic activity and the communication process for any exit strategy. However, we suspect given the weak incoming domestic data the BoJ will delay providing any real clarity. USD/JPY bearish sentiment is expected to fade on a slightly less dovish Fed and disappointing BoJ. The less hawkish Reserve Bank of India, recovering trade data and general positive sentiment around risky EM assets will keep INR supported. We remain constructive on EM as political risks fade and developed markets’ central banks keep lose monetary policy, solid fundamentals and low interest rates to support EM demand (specifically TRY, INR, IDR and ZAR).
Finally, we remain bearish on RUB as the Russian central bank is likely to cut 50bp to 8.75% (consensus 25bp cut) to support sagging economic data and weakened currency.
Gold: Downside risks before the FOMC meeting
While the UK elections have not changed much around the ongoing trend of gold, labour data disappointed financial markets and gold took a hit reaching $1300 against the backdrop of weak US economic data.
While the Fed should increase the US rate tomorrow by a quarter point at the FOMC meeting, markets are also expecting some more hints regarding the Fed rate path for which Janet Yellen is going to show her optimism. Any failure to do so will send the precious metal higher but we consider that the Fed will reiterate their verbal intervention and send gold lower.
On top of that our underlying view on the yellow metal is bearish. One could argue that the US stock market is at all-time high. Monetary policy remains largely accommodative all over the world. For example, the SNB – which expands continuously its balance sheet – underpins the stock market (in particular the US stock market). As a result our target for gold is a support area between $1214 and $1230.
