There has been a lot of reaction on markets in the wake of the Federal Reserve meeting last week. However I thought that I would take a bit of a step back and try to gauge what the impact of the Fed has been on the outlook for the US dollar. The Fed holding rates steady should be dollar negative, right? Well it is not quite as simple as that.
Firstly I should start with the yield curve on US Treasuries, which is the most stark assessment of the reaction to the Fed. Since the Fed meeting, at the shorter end of the curve the 2 year yield has fallen from 0.819% to 0.707%, which is a drop of around 11 basis point (or almost 14% lower). At the longer end, the 10 year yield has dropped from around 2.3% to currently sit around 2.157% (a drop of around 14 basis points (or around 6% lower). Seeing as the market was moving towards pricing in a rate hike on the 2 year, the drop of 11 basis points is understandable as the main focus. However, the 10 year dropping substantially also reflects the concern about future growth expectations, again understandable seeing as the Fed all but blamed the China slowdown for not being able to hike rates.
However, looking at the yield curve of US Treasuries, perhaps the outlook is put more into context. I compare the yield curve today with that of one month. The shorter end of the curve, the yield on the 2 year Treasury(which is where you see the market expectations of rate hikes play out) is again understandably lower as a disappointment of the confirmation of no increase in interest rates has been priced in. Fair enough. However, as duration increases, the yield curve begins to bear steepen to an extent that the 10 year yield is at least 10 basis points HIGHER today than it was a month ago. The flight to safety amidst the concerns over China have not perhaps been as great as some might have you believe. Buyers of longer duration Treasuries have not returned at such a great extent – at least not yet.
The US dollar has subsequently been strengthening especially in the course of the past few days. The big dollar correction due to the Fed not raising interest rates has failed to materialise and if anything it has gone the other way.
This dollar strengthening has taken the Trade Weighted Dollar back to its key medium to longer term pivot level at 96.30 once again. However, this is a level that is consistent with some crucial trading levels on key dollar major pairs. This would suggest we are at a key crossroads again. This level certainly has close links to the $1.1050/$1.1100 medium to longer term pivot band on Euro/Dollar for example. The dollar could be about to make a major break, but what is more likely is that a consolidation will kick in and defer any consistent directional move.
The expectations of a the first Fed rate hike have been scaled back to December or perhaps even into 2016 and many of the major pairs remain rangebound.
EUR/USD has been stuck within the $1.0810/$1.1465 range for several months (leaving aside the spike to $1.1710 in August). The pivot around $1.1050/$1.1100 has played a crucial role on numberous times in 2015 as a key turning point and basis of both support and resistance. Tested as support in early September it is once again coming under pressure (and holding) in the recent sell-off. It would need a 2 day close below $1.1050 to open the downside back towards he key range lows at $1.0810 again.
GBP/USD has been more messy in its consolidation but in the past 5 months the support has been formed consistently around $1.5170 and the upper limit has formed around the resistance above $1.5810. The recent decline (as the dollar has strengthened) has opened the possibility of pressure back on the range lows at $1.5170, however I would be happy to say that even if there were to be a breach, any move would be short lived as I see Cable as being a continuation of the choppy range bound trade now.
Dollar/Yen has been really difficult to call on a day to day basis, but the bigger picture reveals that the pair is now just trading in the same consolidation band between 118.50/121.70 that it did for March/April/May this year. The consolidation is tightening (and possibly going to form a triangle pattern , but such is the tendency for Dollar/Yen to go through periods of either strong trend or lengthy consolidation (I believe this is increasingly becoming a lengthy consolidation), I would not be betting on any directional break any time soon.