The Fed meeting tomorrow will most likely result in an announcement of MBS proceeds reinvestment into Tsys, in our opinion. This expectation is shared by a number of market commentators, including Goldman Sachs’s Jan Hatzius. The Fed may not have the will or political ability to expand its balance sheet further (especially after conducting discount rate hikes and test liquidity withdrawals amid pervasive tightening/policy normalization talk just 2-3 months ago), but it does to prevent its balance sheet from shrinking. This is also a first step toward all-out asset purchasing/QE in the latter end of the year if the economic picture continues to deteriorate.
The Dollar Index bounced off its 61.8% fibo retracement, which also coincided with early 2010 support levels, and reclaimed its 200d on a closing basis. It has been declining primarily because of 1. decoupling and 2. dovish Fed expectations. The decoupling thesis is a bit of a circular argument, as a rising USD environment causes foreign bank credit access to seize up and leads to a positive-feedback USD mismatch. Additionally, the US consumer remains the backbone to the global economy, and if the US economy continues declining, expect China’s, Japan’s, Eurozone’s, etc to follow suit. Again, their banks (as are ours) are dependent on a falling USD. As for FOMC expectations, the reinvestment of MBS proceeds has been largely priced in, if 10yr yields/USDJPY are any indication. Continued deterioration of the USD by the FOMC’s statements will require more-than-expected dovishness. If the 61.8% fibo level can hold after the Fed statement tomorrow afternoon, we expect the Dollar Index to begin another strong surge up.
The EURUSD (the biggest cross component of the Dollar Index) sold off from its significant 1.33 resistance level (March & April lows) today, selling back to the 38.2% fibo level around 1.31. If this level doesn’t hold, look out below for the euro. However, we expect a bounce from this level to 1.35, which coincides with the 50% fibo retracement as well as the 200d. From there, we expect a plunging EURUSD and a resumption of the Eurozone sovereign debt crisis.
EURAUD is an important cross to watch as it coils in its symmetrical triangle. Its corr to equity vol (as well as to inverse equity as shown via the SDS ETF proxy below) is significant to all assets. If this thing breaks out, watch out below in risk assets.
Speaking of AUDUSD, it is breaking down from its rising wedge. A retest of the 200d may be in order for the Aussie cross, and if the SSEC resumes its downtrend, the AUDUSD could be putting in a top. Too early to tell but bearish looking in the near term.
Cable found selling at its 61.8% fibo level, as expected in the previous post. Could be beginning to put in a top. If 1.58 breaks on a closing basis, a trip down to the 200d could be next. In the short term, 1.58 should act as support and GBPUSD might find some buying around there. Again, we think GBPUSD is topping while EURUSD has some room to run before topping and expect EUR to outperform GBP.
So is it going to be short USD/long risk or long USD/short risk? We are clearly at pivotal points (in between 200d & 61.8 fibo level on DX and in between 200d and summer highs on SPX), but the following chart of the VIX below suggests vol is about to expand, which suggests the 61.8 level on the USD index will hold and that the majors and equity indices are primed for reversal. This also suggests EUR & GBP vs CAD & AUD are going to outperform. The Bollinger Band VIX trade has been one of the most reliable setups of the last couple years.