Central Bank Watch Overview:
- With a Brexit deal in focus and the US-China trade war de-escalating, G10 currencies’ central banks’ rate cut odds have receded.
- While the Federal Reserve and Bank of Japan are expected to cut rates this coming week, the Bank of Canada has no moves discounted over the next year.
- Retail trader positioning suggests USD/JPY may continue to rally while USD/CAD may continue to fall.
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With progress on the US-China trade war front moving along nicely according to trade representatives on both sides of the Pacific, G10 currencies’ central banks have seen interest rate cut odds drop further in recent days – a trend that has been in place for several weeks now. Gains by global equity markets (the US S&P 500 hit a new all-time high on Friday, October 25) alongside weakness among the Japanese Yen, Swiss Franc, and US Dollar suggests that traders are no longer concerned about the imminent threat of a global recession.
Rate Cut Due at October Fed Meeting
The Federal Reserve has been front-and-center in terms of rate cut expectations driving market sentiment, largely due to the US-China trade war. But now that negotiations are moving in the right direction again, expectations for heavy-handed monetary stimulus have been reduced. Instead of three 25-bps rate cuts being discounted over the next year, there are now only two, and they are front-loaded.
FEDERAL RESERVE INTEREST RATE EXPECTATIONS (OCTOBER 25, 2019) (TABLE 1)
According to overnight index swaps, market participants are currently discounting a 90% chance of no policy change at the October Fed meeting, up from 88% this time last week. Rate cut odds have risen meaningfully in recent months, having sat at 52% one-month ago. Additionally, there is now a 51% chance of a 25-bps rate cut at the January 2020 Fed meeting. After that, however, market participants only foresee a 35% chance of an additional policy move thereafter.
IG Client Sentiment Index: EUR/USD Rate Forecast (OCTOBER 25, 2019) (Chart 1)
EUR/USD: Retail trader data shows 45.99% of traders are net-long with the ratio of traders short to long at 1.17 to 1. The number of traders net-long is 6.98% higher than yesterday and 11.83% higher from last week, while the number of traders net-short is 4.38% lower than yesterday and 5.07% lower from last week.
We typically take a contrarian view to crowd sentiment, and the fact traders are net-short suggests EUR/USD prices may continue to rise. Yet traders are less net-short than yesterday and compared with last week. Recent changes in sentiment warn that the current EUR/USD price trend may soon reverse lower despite the fact traders remain net-short.
BOJ Ready to Enter Race to the Bottom
The Japanese economy remains on weak footing, with low rates of growth and inflation. With the sales tax coming to bite consumption, growth prospects have dwindled further. Against the backdrop of reduced macroeconomic tensions elsewhere, however, the Japanese Yen has suffered in October as risk appetite as reduced demand for the safe haven currency.
Bank of Japan Interest Rate Expectations (OCTOBER 25, 2019) (Table 2)
According to overnight index swaps, there is a 70% chance that the BOJ joins the “race to the bottom” among G10 currencies’ central banks with a 10-bps rate cut this week. Rate cut odds have risen sharply in the past week, from 35% to 70%. To this end, the BOJ may just be getting its rate cut engine revved up: markets are pricing in a 63% chance of a 10-bps rate cut at the March 2020 BOJ meeting.
IG Client Sentiment Index: USD/JPY Rate Forecast (OCTOBER 25, 2019) (Chart 2)
USD/JPY: Retail trader data shows 48.60% of traders are net-long with the ratio of traders short to long at 1.06 to 1. The number of traders net-long is 0.93% lower than yesterday and 6.52% higher from last week, while the number of traders net-short is 0.56% higher than yesterday and 3.75% lower from last week.
We typically take a contrarian view to crowd sentiment, and the fact traders are net-short suggests USD/JPY prices may continue to rise. Positioning is more net-short than yesterday but less net-short from last week. The combination of current sentiment and recent changes gives us a further mixed USD/JPY trading bias.
No Rate Moves for BOC Through September 2020
The Canadian economy continues to show signs of resiliency in the face of an uncertain global growth environment, with USD/CAD quickly approaching its yearly lows even though its commodity currency brethren have recently hit yearly lows versus the US Dollar. Stability in oil prices could with a relaxation in tensions between the US and China are catering to a reduction in Bank of Canada rate cut expectations.
Bank of Canada Interest Rate Expectations (OCTOBER 25, 2019) (Table 2)
According to overnight index swaps, the chance of a BOC rate cut this year has been effectively eliminated: there is a 0% chance of a cut at the October meeting, and only a 14% chance through the end of the year. Last week there was a 4% chance of a 25-bps rate cut at the October BOC meeting. Rates markets are expecting a quiet BOC for the foreseeable future: no rate moves are priced-in through September 2020.
IG Client Sentiment Index: USD/CAD Rate Forecast (OCTOBER 25, 2019) (Chart 2)
USD/CAD: Retail trader data shows 70.01% of traders are net-long with the ratio of traders long to short at 2.33 to 1. The number of traders net-long is 12.18% higher than yesterday and 34.21% higher from last week, while the number of traders net-short is 3.73% lower than yesterday and 15.98% lower from last week.
We typically take a contrarian view to crowd sentiment, and the fact traders are net-long suggests USD/CAD prices may continue to fall. Traders are further net-long than yesterday and last week, and the combination of current sentiment and recent changes gives us a stronger USD/CAD-bearish contrarian trading bias.
FX TRADING RESOURCES
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--- Written by Christopher Vecchio, CFA, Senior Currency Strategist
To contact Christopher Vecchio, e-mail at cvecchio@dailyfx.com
Follow him on Twitter at @CVecchioFX
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