My 2 Cents (Fed Preview)
Well time is flying while we are having fun and the next FOMC meeting is upon us where we will be confronted with the same question again… will they or will they not start to acknowledge that maybe it is soon to think about thinking to taper (that seems to be some of the FED Govs favourite sentence) and I would definitely agree.
Yes, I am well aware that some of the Covid related price rises could well be transitory and the biggest part of the overshoot in CPI may well come from Covid related parts of the economy while the non-Covid part is still behaving somewhat better BUT at the same time, we do start to see some wage inflation coming in and we do NOT yet know where the current rush in CPI will peak… so even if we were to remove transitory, it could still mean that Inflation is sticky and maybe it is indeed back, at least that is what I am thinking.
BUT transitory or NOT transitory… yes, I agree, we don’t need to panic and start hiking rates too early, I get that and I agree with that… WHAT I do NOT agree with is the fact that the FED policy is still set at March 2020 emergency and no matter what you feel about the current recovery, real or not real… we are NOT at emergency levels anymore…. QE is really doing very little to address some of the current imbalances that the K recovery throws at us…. That is now more in Governments hand to address….. and I understand that the FED doesn’t want to go too early, as the cost of that could be bigger than the risks BUT you cannot pin point this transitory effect that well, that you would NOT want to at least have some insurance against inflation really becoming an issue…… to me, there is NO excuse NOT to start reducing QE and start to get that taper story rolling….
The FED can easily communicate this in a way that the market understands that this is not a Taper that happens in a hurry and doesn’t mean hikes come earlier than currently planned BUT that the state of the economy, the continued improvement warrants less accommodation. You just cannot tell me that it is normal, again transitory or not… to just shrug your shoulders if you have a Core CPI at 3.8% and a headline print at 5%… you just cannot close your eyes and bury your head in the sand……
Now the key question… ahead of the last CPI, I felt that Jackson Hole would be the best place for the FED or FED Chair Powell to signal to the market that the September meeting is live.. hence chance that some form of taper will be announced in the Sept meeting…. But since the fresh print in the last CPI, I do wonder if some FED members start to get a tad nervous and if we start to hear a bit more hawkish headlines tomorrow.
Market wise, we have seen a USD bounce on Friday, one day post the high CPI and that bounce might have been more related to the fact that the market finally noticed that AUD, NZD and CAD yields have come off more than the US one… so I do NOT necessarily think the Friday USD rally was the market reacting to the US CPI 24h earlier….
For me, the FED meeting creates some asymmetric risk opportunities…. Either with being LONG USD into the event or short some Risk crosses or both…. The market isn’t really looking for a hawkish meeting BUT starts to get a bit more unsure about the risks… we see USD EM is a tad better bid vs the recent EM strength, maybe another sign that the market doesn’t completely ignore the risks of a hawkish outcome….
To me, the game plan is quite clear for myself….. I will be long some USD into the event and short some risk crosses and then will react quickly…. On a hawk, I would add to USD longs and add to risk shorts…. On a dove, I would immediately cut all my positions and possibly buy some Risk crosses, as a dovish FED in June means…. No risk until August Jackson Hole and the market might go on a carry frenzy. Given I am a USD bull all year and have no plan to change that, I would pass on selling USD’s to go short on a dovish outcome BUT have no problem to sell maybe EURAUD or buy AUDJPY or similar.
For those a bit more adventurous , a dovish outcome would probably open more downside in USDZAR, USDMXN and those that really feel up for it…. might even sell USDTRY and earn some proper carry during summer…. A hawkish meeting will see a lot of the recent EM gains being undone rather rapidly.
In other words, the FED meeting to me is a very binary one… mainly due to the fact we enter the summer market…. That means, some of you might just prefer not to pre-empt the meeting and act post meeting, which I can fully understand. The only reason I try to be involved pre meeting is really from the fact that I can see some asymmetric risk, which was greater on Thursday before the USD rally and a tad more mixed today…. So a USD dip into the FED would definitely suit… and I will allow myself a lot of time in the run up to the meeting to place my bets.
Should we indeed get a dovish outcome, we will get risk on in June and July and parts of August and then we will focus on Jackson Hole and see if Powell drops the bombshell in August… BUT one thing I have no doubt… the FED has to react soon, otherwise it might really lose control as well as credibility.
Long story short… I will be long some USD and short some risk into the event BUT react very quickly thereafter, depending the outcome… either add risk to existing positions or flip things around and go with what looks like the summer trade.
Good luck everyone