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The Dollar Remains Slightly In The Defensive Ahead Of The Fed Meeting

Markets

Contrary to Monday, European and US markets yesterday failed to withstand a new risk-off wave initiated by China’s regulatory overhaul. US data (durable goods orders, House prices, consumer confidence) were ok or even strong, but failed to change the course of events. European equities lost 0.5%/1.0%. US indices also finished in red but off the intraday lows (Dow -0.24%; Nasdaq -1.2%). The flattening in core yields continued unabatedly with German yields declining 1.3 bp (2-y) to 2.7 bp (30-y) and the US curve between 0.6 bp and 4.8 bp for 10’s and 30’s. (10-y) real yields dropped further in uncharted territory with new historic lows at-1.90 % (Ger) and -1.15 (US). The 5-y $ 61 bln US Treasury auction was ‘average’. Despite the risk of the dollar slightly underperformed. EUR/USD closed at 1.1817. DXY at 92.42. Sterling even outperformed in the broader USD decline. EUR/GBP closed at 0.8514. The 0.8504/0.8472 support/range bottom is coming within reach. In Hungary, the forint rebounded to the EUR/HUF 359 area as the MNB raise policy rates by 0.30%.

This morning, Asian equites are losing further ground but China ‘outperforming’ suggests that the pressure from the regulatory measures is easing. Results from the US big tech names (Apple, Microsoft, Alphabet) triggered a mixed market response. Regulatory fears also hurt the yuan with USD/CNY holding north of 6.50. The dollar remains slightly in the defensive ahead of the Fed meeting (USD/JPY 109.75, EUR/USD 1.1820).

Today, only second tier data will eb published. So today’s session could to be a long drawn-out countdown to the Fed decision. However, the market recently didn’t need data or other external input to develop its own internal dynamics. This might still be the case today. In addition, it isn’t that easy to pinpoint what might be the ‘favored’ outcome for markets from today’s FOMC meeting. On policy stricto sensu, no change is expected. The Fed president will acknowledge a continuation of the economic recovery. At the same time, risks (delta variant) persist and the labour market has a long way to go to reach the Fed’s definition of full employment. Inflation will probably still be labelled as temporary, but it will be interesting to see whether there might be a subtle change in tone or a stronger reconfirmation that the Fed will take action ‘if necessary’ (which probably still isn’t assumed to be the case at this stage). The process of ‘thinking about thinking about tapering’ will continue, but more concrete guidance will probably only come in August (Jackson Hole) or at the September meeting (with new forecasts ). So rather than from the official statement, interesting insights maybe have to come for the press conference. Any specification on what the Fed sees as ’temporary/transitory’ (on inflation) would be interesting. We’re also keen to hear Powell’s view on current development in the (bond) market. In theory, low long yields still can be seen as favourable financing conditions supporting the recovery. However, can a central banker really be happy with an aggressive flattening of the yield curve and historically low real yields at this point in the economic cycle? A steeper curve might give some more comfort on markets (and other economic agents’) confidence in the economic recovery. However, there is probably no silver bullet for the Fed to address current market schizophrenia with low (real) yields & at the same time near record equities. From a technical point of view 1.12% and -0.47% are next support levels on the technical charts for the US and German 10-y yield respectively. The dollar recently took a pause, but no important support has been broken yet. Powell’s tone on whether or not the Fed will give more weight on inflation is important. No change in the ‘temporary inflation narrative’ cause some further USD easing EUR/USD 1.1881/1895 (currently 1.1820) and DXY 92.00 (currently 92.50) are first technical reference on the charts.

News headlines

Australia Q2 headline inflation jumped 0.8% Q/Q and 3.8%, the fastest pace in 13-year, as base effects kicked in. However, the underlying Trimmed Mean measure rose a much more modest 0.5% Q/Q and 1.6% Y/Y, below the RBA 2-3% target. However, the focus for policy short-term is more on the impact of the new corona wave, rather than on inflation. AUD/USD is easing a few ticks this morning (0.7350 area).