Connecting The Dots: Show Me The Plot

With little in the way of tier one economic data today to whet the market appetite, I expect the FX traders to stay "home on the range" but continue to skew the US dollar to trade bid on dips against the steeper tightening profile from the Federal Reserve which should push 2–5-year US yields higher.

However, as of year-end approaches, unless the ideal setup comes to fruition, FX trader's bias is to de-risk from more consensus trades (short EUR), especially since the US CPI was not a source of stress for equity markets nor short US dollar positions.

The doves will argue an on-consensus print gives the Fed scope to credibly separate tightening from tapering in its dot plot and qualitative messaging at this week's FOMC meeting, setting up steeper curves, a weaker USD, and a solid year-end for equities.

The hawks will argue it is unlikely we have seen peak US CPI, so last Friday's post CPI adjustments should eventually be faded significantly, with most economists calling for a 7 % plus CPI rise over the next couple of months,

But for this week, the critical question for FX traders is, will the Fed push back against the markets sooner rate hike pricing?

The recovery in risky assets and lower vol in US front-end rates have allowed the Dollar to trickle lower from its late-November highs. But the Fed will determine the currency's near-term direction. If the "dot plot" at this week's FOMC meeting shows a two-hike median for 2022, we may see the recent USD weakness extend a touch while a shift to three or more hikes for 2022 would trigger a stronger US dollar (markets currently price 2.6 Fed rate hikes next year).

There is a wide range of outcomes. My baseline outlook envisions three Fed rate hikes next year alongside solid global growth suggesting dollar-neutral central bank divergence themes will make more sense from that point; short EURUSD and short AUDCAD make sense. Beyond this month, which is usually a wacky month for trading currencies, incoming inflation data will be in the driver seat and should map the course for the Dollar.