The stronger than expected December ADP survey on private payrolls (140,000 vs. 40,000 expected) should make today’s interest rate decision a contentious one, especially after Q4 gross domestic product (GDP) slumped to 0.6% (exp 1.2%) following 4.9% in Q3. Considering the ADP survey’s correct signaling of the direction of the December payrolls report, today’s figures should add to the surprise element of the Fed’s decision and increase the volatility of market’s reaction to the decision. This implies that a 25 basis point cut may trigger pronounced losses in equities and extend a broad dollar rally as well as considerable declines in yen crosses. A 50 bp cut should be broadly negative for the greenback. We scale down our expectations for a 50 bp rate cut to 55% from 60%, raising odds of a quarter point move to 45%.
The dollar had weakened across the board before the U.S. data, taking center stage from what would normally be broad yen weakness after a record $11.4 billion Q4 loss by UBS emerged twice more than expectations. Rumors of an additional $10 billion in mortgage related write-downs from Merrill Lynch and talk of imminent downgrades of monocline insurers by the major credit agencies. We expect the tug of war between reduced risk appetite (manifested in yen strength) and deepening Fed cuts (manifested in broad dollar weakness) to continue for as long as market psychology continues to set the Fed’s actions.
The 2:15 pm EST Federal Open Market Committee (FOMC) decision was widely expected to produce a 50 bp cut in the Fed funds rate, which is seen broadly dollar negative and may prompt gold towards $950 in the event that we see a lasting rally in U.S. equities of at least 2.0% in the broad equity indices. The Aussie, Kiwi and loonie are seen as the main beneficiaries from a greater Fed move. Nonetheless, even in the event that U.S. stocks fail to sustain their gains following an aggressive Fed move (50 bps), we anticipate dollar weakness to extend across the board.
We should warn that we are not completely ruling out a 25 bp rate cut in light of the recent stability in stocks and of the argument that last week’s market erosion was a result of losses triggered by a single bank rather than broadening systemic risk. The fact that the European Central Bank (ECB) did not even hint a cut when the second largest French bank shed more than $7 billion in its books may reflects the hastiness of the U.S. central bank. A 25 bp cut today would be largely negative for stocks and positive for the dollar against most major currencies except the yen, which we see to be the broad winner in this scenario.
USD/JPY supported by ADP
We expect USD/JPY to extend climb past 107.60 as markets scale down certainty of a half a point Fed cut. Although a 25 bp cut should be dollar positive, we may see a turnaround in the pair in the event that deep equity deals a blow to risk appetite and we get the same scenario as on the Dec. 11 FOMC, when the Fed’s 25 bp easing provoked sharp losses in U.S. and global equities. Key upside capped at 107.90. Interim support stands at 106.90, with key foundation standing at 106.40.
Euro risks on downside following ADP
Broad dollar weakness helped the euro shrug weaker than expected French business confidence figures and falling Spanish retail sales. Even falling risk appetite from the 42% decline in BNP Paribas’ profits and UBS’ fresh write-downs have failed to destabilize the single currency. One notable remark today was from ECB member/Dutch central bank governor Nou Wellink, who broke from protocol and said the Fed’s policy is too lose. Central bankers rarely express disagreement with other central banks’ policies, especially when it involves the world’s two biggest central banks. This suggests that the ECB will stick with current interest rates for some time to come despite deteriorating sentiment in the region.
A 50 bp cut move is seen propping the EUR/USD to as high as $1.4850, especially if such a move is reached unanimously. The stronger than expected ADP survey may add more a surprise element to a half a point move, which should prolong the euro’s gains. A 25 bp rate cut is seen dragging the pair towards 1.47, nearing support at the 50-day MA of 1.4650.
Sterling Vulnerable to Fed Surprise
Sterling stabilizes on disappointing UK GDP figures following a stronger than expected ADP survey. We think the data will offset one another and maintain Cable below 1.9930. UK mortgage approvals slumped to their lowers level in record, helping to make the case for a BoE easing next month. Short-term techs suggest support firm at $1.9820. In the event that the Fed opts for a 25 bp cut, we should see a break below 1.98 to as low as 1.9760. The ADP’s surprise element function means that half a point move may test the 1.9970 level.
Ashraf Laidi
Chief FX Strategist
CMC Markets US
a.laidi@cmcmarkets.com
