The Fed Just Threw Their Models Out

Admin, August 28th, 2020

The Fed confirmed they are abandoning their fixed 2% inflation target. Which is not such a bad idea given they have not hit that target since 2012… Instead they will adopt a 2% inflation rate “on average”, allow inflation to rise above 2% for “short periods of time” whilst keeping interest rates lower to boost growth.

What is more striking is that the Fed has much more wriggle room to ‘wing it’ which could make them far harder for investors to read unless they provide top-notch forward guidance.  Whilst Powell made no direct comments on forward guidance, the following points he raised underscore how the Fed have opened-up the playing field and effectively abandoned their models.

  • Policy will not be dictated by a formula
  • The Fed is not tying itself to any particular method to define average inflation
  • The new framework won’t dictate decisions at particular FOMC meetings, but it will “inform those decisions”
  • The Fed places employment before inflation in the new monetary policy strategy
  • Whilst the Fed is “mindful” of the burden higher food and living costs post, they want to prevent the “adverse dynamics” of weak inflation expectations seen in other countries.

In a nutshell, the Fed have abandoned the Taylor-rule approach and they are going to wing it. We hope they fill in the gaps in due course.

In other news, US Q2 GDP was revised upwards from -32.5% to -31.7% QoQ. Big whoop…although this was buried in the hype around the Fed’s change of policy.

Markets Reaction:

  • Risk-on saw JPY was broadly weaken and send commodity FX higher. AUD/JPY, NZD/JPY and CAD/JPY were the strongest of the session, GBP and EUR were the weakest currencies
  • Mixed picture for USD with the dollar index (DXY) closing higher for the day and on track for a bullish doji
  • Gold and Silver printed bearish outside candles as investors closed their safe-havens and moved into risker assets
  • S&P 500 E-mini futures produced a spinning top doji yet remain just off of their all-time highs. The VIX (volatility index) spiked to 28 and settled at 24.47

The risk-on vibe has continued during the early Asia session with AUD and NZD leading and CHF and JPY seeing further outflows. We’d prefer to seek some form of consolidation before jumping onto the back of overnight risk-on moves.

It is a quiet calendar to finish the week. If there are to be any moves of interest it may be from the follow-through of Powell’s speech as investors fully digest these big changes to Fed policy and large traders position themselves accordingly.

 

AUD/JPY: Up, Up and Away?

Bullish range expansion cut through 76.86 resistance like butter and was the strongest performer yesterday (and continues higher today).

Momentum remains strong although a pullback towards the original breakout level could help initiate a second wave of buying from the bull-camp.

  • If successful, the ascending triangle projects an approximate target around 81.20
  • Alternatively, a bullish channel could be used to project a dynamic target over time

 

EUR/JPY: Bullish Momentum Carves Out a Prominent Low

Whilst there was some noise around the 50% retracement level, the support zone highlighted yesterday held and bulls are back in control. From here bulls could seek continuations patterns or periods of consolidation on lower timeframes for potential long setups.

However, prices are currently stalling at resistance so bulls may want to wait for a break above 126.13 or see if prices retrace to provide a lower entry.

  • Bias remains for a retest of the 126.75 highs
  • A break below 125 invalidates the bias

 

Nikkei 25 (JP225): Potential bull-flag below resistance

The bull-flag we highlighted on the 20th August remains in play although resistance has been found around 23,350. However, another bull-flag appears to be forming on the H4 chart and the 38.2% Fibonacci level and 50 eMA is providing support.

  • Given the bullish trend on D1 and potential continuation pattern on H4, we would assume trend continuation with a break above this week’s high 23,431.13
  • A break below this week’s low assumes a deeper correction (unless momentum is strong, in which case it will be removed from the bullish watchlist)

 

Watchlist Update:

USD/CAD: We saw a break to 7-month low after Powell’s speech yet prices are now anchored to the 200-week eMA. We’d prefer to see it decisively lower than the 200 eMA before the weekend closes out, to avoid any gaps higher over the weekend from such a critical juncture.

DJI (US30): The bullish structure and bias remains intact and it is inching towards the initial gap target around 28,800. Whilst we half expect a possible price reaction/ retracement around 28,800, we remain bullish overall whilst prices remain above 28,000.

Brent: Removed form watchlist. Bearish momentum saw prices roll over before it could break above resistance.

AUD/NZD: Removed from watchlist. Despite a minor break of last week’s bearish pinbar, AUD and NZD are the strongest majors so it lacks the divergent theme for this to work in our view.

Silver (XAG/USD): Whilst we remain bullish overall for silver, we’d prefer to step aside for now following yesterday’s bearish outside *and bearish engulfing) candle. Fundamentally there’s still a strong case for higher precious metals, but the technicals do not match up with that view over the near-term.

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