It’s hard to recall a week where we had so much to focus on, and regardless of the asset class, there is news which affects that pricing structure.
Tracking back to Friday’s session and markets got pretty excited about the WSJ article, weighing an earlier-than-expected end to their portfolio runoff. The fact that we saw the USD index trade 0.8% lower, and the S&P 500 0.8% higher, shows the markets incredible sensitivity to liquidity dynamics driven from changes in the Fed’s balance sheet. Early termination of the normalisation program is a game-changer, although, we still have some way to go until this becomes the market base case. 
We could potentially consider the article a trial balloon, and one the Fed will be more eager to consider should it become their view that recession risks globally are a genuine threat.
Eyeing the FOMC meeting
We may even hear more on the balance sheet in Thursday’s FOMC meeting (06:00 aedt), although one suspects this is unlikely. That said, there is no doubt Jay Powell will be intently probed in his post-meeting press conference. Recall, this is a man, who markets feel has made a number of faux pas in the last few months, so one suspects he’ll be fully prepared for the onslaught. 
The Fed will likely use this meeting as a chance to formally aggregate all the recent views we have heard, that being one of ‘patience’ and ‘wait and see. We should also hear a formal change in current guidance that further gradual rate increases are needed and consistent with sustained expansion. Given all we have heard of late, it feels this meeting should put the Fed collective formally on the same page as market pricing, where we can see the rates market now pricing just seven basis points of tightening between March and December. In theory, the FOMC meeting shouldn’t be a volatility event.
The same cannot be said of Australian markets, which are my primary focus this week. AUDUSD implied volatility (vols) expiring at the end of the week, show the market priced for a 57-point move (in either direction) from the current spot price of 0.7158. This implied move seems low in my opinion, especially considering the event risk. Today’s NAB business condition fell to 2 (from 11), marking the weakest levels since September 2014 and we see the internals in the survey just plain ugly. Granted, business confidence remained at 3, but if the Reserve Bank needed more evidence of a feedback loop between the decline in house prices, the tighter credit environment and drawn down in the equity markets in Q4, then they have it. 
Swap markets are pricing a 44% chance of a cut by year-end from the RBA, and around 70% chance if we extend this into 2020 and this implied probability will be thrown around by the outcome of tomorrow’s CPI print. Rallies in AUDUSD above 0.7210 are to be sold (in my opinion), although it’s a tall order to think we get there. Should we see headline come in at 1.7%, which is what is expected, it will mark a period where headline inflation has missed the bank’s target in 15 of past 17 quarters, and it will become a base case (i.e. above 50%) that the RBA cut in 2019 and those analysts who have pencilled in a hike this year will likely be reviewing their call.
We can go back to February 2015 as our case study, when the RBA commenced the last easing cycle, cutting rates from 2.5% to 1.5%. We can assess the bank’s guidance in the lead up to its easing cycle and find it was only two months earlier in December that the bank told us that on present indicators the most prudent course was for stability in rates. 
I find it hard to see the bank easing anytime soon, although they will try and make it clear politics are not a factor given the impending election. We still need to see the full report on 1 February on the Royal Banking Commission, and one would believe we would need to see APRA move more intently before the RBA do. 
The RBA will lose its ‘next move in rates is up’ stance, although, we may have to wait until the February meeting minutes on 19 February for confirmation of that. That said, we live in a world where central banks use guidance as its first line of attack, so before we genuinely think about the bank cutting, the first protocol is moving to an explicit easing bias. Moving to an easing bias would promote the RBA as one of the most dovish in G10 FX and while they are miles away from using their balance sheet to influence inflation expectations, such as we have seen from the BoJ, Fed and ECB, it will be a more dominant talking point from market participants. 
While AUDUSD and the AUD crosses will get a work over this week, gold priced in AUD’s (XAUAUD) looks bullish. On the daily, we can see the price has broken out of the consolidation pattern, and we can’t rule out a re-test of the 3 January highs. 
Other global event risks to ponder
While much of the focus here has been around a view of looking domestically, we have to pay attention to US-centric event risk with ISM manufacturing, retail sales and non-farm payrolls. We also have the start of high-level talks between the Chinese Vice-Premier He and Robert Lighthizer and Peter Navarro. This comes at a time when the US has now formally charged Huawei CFO with financial fraud. Timing, it seems, is never ideal. Watch USDCNH as a guide and its hard to see any real CNH weakness in the short-term and a close through 6.7383 would likely spur USD weakness more broadly.
Capping things off, moves in GBP are also firmly on the radar with markets watching for amendments to May’s ‘Plan B’, which could significantly shape the next Brexit vote due on 13 February. Two amendments, in particular, stand out, these being the Cooper-Boles amendment, that completely removes a ‘No Deal’ Brexit as a scenario, with a guide to extend Article 50 if no deal is reached by 26 February. The other, the Brady amendment, which is focused on the backstop and replacing the existing idea with ‘alternative arrangements’. We shall see which amendments are picked, as they could dictate the direction of Brexit. 
Published by Chris Weston, Head of Research, Pepperstone