- The Fed Chairman made a concerted - if measured - bearish shift in his rhetoric and risk trends ran with the news
- Meanwhile, the Fed's financial stability report issued warning, the IMF downgraded growth and Trump revived auto tariff threats
- As expected, the BOE's stability report was dire on a bad Brexit outcome, but it was the government's own forecast that concerns
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Markets Rally as Fed Chairman Powell Softens His Language
It wasn't difficult to isolate what was moving the markets this past session. On a day where there were a host of important, thematic updates; one event stood out above the rest - mainly because it was the only one that bulls could reasonably point to for enthusiasm. Fed Chairman Jerome Powell spoke Thursday afternoon at a speech and Q&A that was meant to be on the bond market, but the market was looking for policy clues. They found what they sought (see more of the his remarks here). In a fairly wide ranging discussion, the comments the investment and speculative rank honed in on would seem pretty nondescript for the uninitiated. The central banker said the current Fed Funds rate range (at 2.00 - 2.25 percent) was "just below neutral". Translating from central bank speak, the Fed is closer to ending its current phase of rate hikes. In the specific Fed dialect, it is attempting to convey that traders should be prepared for the possibility that they back off of their previously established forecasts. While Powell was referencing a target range of 2.50 to 3.50 percent which could still mean a healthy string of further tightening (4-5 hikes if they are aggressive), they have been wielding forward guidance as a scalpel. This was intended to reduce the volatility in the event that they lower their rate forecasts come the December FOMC meeting where they update the Summary of Economic Projections (SEP). So, the Fed may pursue fewer hikes than was previously expected, and the US indices put in for hearty rallies. By past years' logic, this could have proven the source of a next bullish phase. In current conditions, slowing or even stopping this hawkish course will not justify a new speculative reign when assets are still so richly priced and there are so many other threats afield.
S&P 500 Chart (Daily)
The Other Warnings that Were Conveniently Ignored for an Equity Rally
What makes it easy to isolate what market's decided to focus on was that recognition that nearly every other material systemic headline through the past session carried a negative connotation for speculative assets. From the Federal Reserve itself, there was the (unexpected for me) release of the group's new semi-annual financial stability report. In it, the group maintained its sense of optimism for growth and suggested risks were only 'moderate'. Yet, their list of concerns - rising corporate debt, external risks such as trade wars and Brexit, elevated asset prices - may be considered more important to the discerning trader. A more prosaic concern was highlighted by the the International Monetary Fund (IMF) which issued an unfavorable update on its recently revised GDP outlook. Despite downgrading growth projections just recently, the group and Director Legarde said recent data suggested it may be even weaker than assumed. That warning was followed by another plea for global leaders to steer away from protectionism. For me, the most important update on the day - and troublingly overlooked - was US President Donald Trump's follow up on his critique of General Motors. Not content with threatening to simply consider removing all of the company's government subsidies for planning to shutter five North American plants and shedding over 14,000 employees, Trump said his administration was reviving its assessment of tariffs on imported autos. This threatens to spread the open trade war from just US-China to encompass the European Union and Japan. The President previously agreed with the leaders of these two economies to avoid such taxes so long as they negotiated, but that vow is clearly under pressure. If this gains traction, it would not be far-fetched to expect stalled global growth.
GM vs. EUR/USD Chart (Daily)
Pound is Acclimating to a Troubling Brexit Outcome
While there was a lot going on in the US markets, the UK was facing its fair share of fundamental buffeting. And, similar to their American cousins, what the British investors were seeing was generally discouraging and bearish. We were due the Bank of England's (BOE) financial stability update Wednesday morning, and the general tone of the group prepared us for what they were likely to evaluate. Yet, that early release was pushed back to later in the day to allow for the government's own update on growth forecasts under different Brexit scenarios. There is considerable criticism heaped on the BOE and its Governor (Mark Carney) for supposedly being alarmist, which could be argued - though I think that is a stretch. The government, however, has a Brexit supporter at the steering wheel; so we would expect the positive potential earning a little more attention. Despite that environmental skew, the report found that all of the scenarios would leave the UK economy weaker than a status quo path. Of course, there are legal and social considerations in this divorce, but the economic impact still matters...a lot. As for the central bank's assessment (see the full run down here), the encouraging aspect of the update was the view that country's banks would weather a worst case scenario. That is saying something considering that scenario includes a 4.7 percent drop in GDP, surge in the jobless rate to 9.5 percent, housing prices that drop by a third, commercial real estate losing 40 percent in value and the Pound dropping 27 percent. Alternatively, the crash out scenario would still lead to an economic crunch and financial pain. Despite the implications, the Pound held its ground. That said, I would not consider the current level of the currency an accurate reflection of the risks that can still arise from this situation.
GBP Index Chart (Daily)
Aussie and Kiwi Utilize the Skew, Euro and Franc Unmoored, Oil Threatens to Continue
At the moment, the Dollar and Pound are draw in on systemic fundamental themes. The Yen can be included in that mix as its bearings are defined by general risk trends. With the jump in equities, emerging market and high yield measures through US trade this past session, it should surprise no one that the carry trade Yen crosses were also finding some lift - which makes USDJPY's reticence even more interesting. Rounding on the most liquid currencies in the FX market, the Euro has held steady. That is not on the virtue of its fundamental health but rather owing to the lack of fresh headlines amid this news run. The world's second most liquid currency is still dealing with the existential risk posed by Italy's refusal to meet EU budgetary limits. It was suggested that the EU would push for debt procedures before Christmas. What's more, monetary policy is still a lingering threat to the currency. Just as with the Dollar, the outlook for the ECB holds little potential to 'impress' but has plenty of room to 'disappoint' the pumped up Euro. Meanwhile, the Aussie Dollar has defied a terrible 3Q construction activity report that makes material the RBA's concerns, but the currency instead took advantage of general risk appetite to rally despite its troubles. That same lift was observed in the Kiwi Dollar as both deeply discounted currencies seem to have an appetite for encouraging perspective. Key event risk ahead includes the Swiss 3Q GDP, the ECB's favorite Euro-area data and Aussie private capital expenditure reports, but don't expect too much direct response. Even the speculative opportunism seems to be held in check. Crude oil, after consolidating for another brief stint (three days), dropped back to cycle lows this past session. Will this 30 percent-plus tumble continue without even a moderate level of correction? We discuss all of this and more in today's Trading Video.
AUD Index Chart (Daily)
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-- Written by John Kicklighter, Chief Currency Strategist for DailyFX.com