Daily Market Outlook, September 21, 2023

Munnelly’s Market Commentary…

Asian equity markets faced pressure following the Federal Open Market Committee's (FOMC) hawkish pause, where the Fed's dot plots indicated one more rate hike by year-end and fewer expected cuts next year. The Nikkei 225 slipped below the 33K handle as Japanese yields surged to decade highs. The Bank of Japan commenced its two-day policy meeting.Both the Hang Seng and Shanghai Composite followed suit with a decline, mirroring the cautious sentiment in regional markets. However, losses in the mainland were initially softened after the Chinese Cabinet expressed its commitment to accelerating the development of the advanced manufacturing sector. Resilience was also observed in developers after Guangzhou adjusted purchase rules for several districts.

The unexpected drop in UK Consumer Price Index (CPI) inflation to 6.7% in August from 6.8% in July has raised doubts about whether the Bank of England (BoE) will raise interest rates today. The BoE announcement is scheduled for midday. It's worth noting that the catalyst for the inflation slowdown was unusual price fluctuations between July and August, possibly due to the timing of price collection and school holidays that elevated prices in July. This resulted in a significant decrease in airfares and hotel prices in August. Nonetheless, the expectation is still for the BoE to raise rates by another 25bps to 5.50%, marking the 15th consecutive increase. This decision is driven by the fact that inflation remains well above the target and wage growth remains elevated. It's possible that the vote may not be unanimous, with Dhingra expected to vote for no change, with Mann potentially voting for a larger hike. Recent data have increased uncertainty about future rate hikes. A rate rise today is seen as having only a 50% probability, compared to being viewed as almost certain in recent weeks. Markets increasingly sense rates are now seen as potentially terminating at 5.50% for this cycle, a marked reduction from earlier projections. The BoE's forward guidance will be closely scrutinised, with any softening of previous statements indicating a potential peak in rates. However, the BoE will most likely emphasise that policy is expected to remain restrictive for a considerable time inline with other major central bank stances. The Monetary Policy Committee (MPC) will also need to announce its plans for asset sales (quantitative tightening or QT) over the next year, commencing in October. Recent rhetoric suggests that this process may be accelerated, markets are looking for a potential £100 billion in sales, up from around £80 billion seen over the past year.

Sateside, investors will analyse the hawkish pause from the FOMC on Wednesday, as well as the significant central bank activity in Europe. Weekly initial jobless claims and continuing claims are expected to increase slightly. The Philadelphia Fed manufacturing survey will be watched closely, particularly in the context of the upside surprise seen in the Empire manufacturing report. Additionally, August existing home sales data will be released after the market opens.

FX Positioning & Sentiment

FX options appear to be underpricing the risk associated with Friday's Bank of Japan (BoJ) policy decision on USD/JPY. Currently trading at 2023 highs of 148.46, there might be an assumption that there's more potential for policy tightening or FX intervention. While FX options acknowledge the risk, the premiums for protection are significantly lower than in previous instances. The overnight expiry now includes the BoJ, with its implied volatility ranging from 12.0 to 20.0. The premium to break-even spans from 74 to 124 JPY pips, a notable decrease from the peak of 40 vol/240 JPY pips seen in July during the BoJ meeting. Interestingly, the implied volatility premium for JPY calls over puts in overnight expiry is higher at 3.3. However, it's worth noting that the USD/JPY downside premium was above 10.0 before the BoJ meetings in March, April, and July. This suggests that while there is some recognition of the risk associated with the BoJ decision in FX options, the market may not be fully pricing in the potential impact on USD/JPY, especially in terms of downside protection. This could indicate a degree of complacency or the expectation that the BoJ is less likely to introduce significant policy changes or interventions in this meeting.

CFTC Data As Of 15-09-23

EUR net spec long drops to 113,080 contracts from 136,231
JPY short rises to 98,713 from 97,136
AUD short lower at 79,533 from 83,537
GBP long slightly smaller at 46,174 from 46,384 (Source: Reuters)

FX Options Expiries For 10am New York Cut

(1BLN+ represent larger expiries, more magnetic when trading within daily ATR)

EUR/USD: 1.0600 (1.8BN), 1.0640-50 (771M), 1.0675 (832M), 1.0700-10 (1.5BN), 1.0725 (555M), 1.0745-50 (1.6BN)
USD/CHF: 0.8890-0.8900 (571M), 0.8950 (290M)
GBP/USD: 1.2300-05 (853M), 1.2330-35 (623M), 1.2350 (211M), 1.2400 (375M)
EUR/GBP: 0.8625 (471M), 0.8645 (324M), 0.8660 (250M), 0.8700-05 (558M)
AUD/USD: 0.6275 (744M), 0.6450 (1BN), 0.6500 (1BN)
USD/JPY: 147.50 (316M), 148.00 (619M), 148.50 (406M), 149.75 (600M)
EUR/JPY: 157.50 (230M), 157.70 (290M), 158.50 (205M)