The FOMC made its policy decisions today, and as expected, there were no changes to the policy. The most significant take away in our opinion, is that the Fed expecting transient inflation. Most committee members expect inflation to rise this year, with a median estimate of 2.5%, after which they expect inflation to drop back down to 2% in 2022. Hence, while bond market vigilantes and private forecasters can continue to talk about inflation, the Fed intends not to move until their full employment objective is met and will be patient on inflation. Monetary accommodation continues!

In 2021, the major theme in markets has been relation, i.e., higher growth and higher inflation. However, gold has received little love during this period. Why? This is because gold, unlike other commodities, has significant currency characteristics and is far less procyclical than other commodities. Gold demand is usually for its value as a store hold of wealth, which can be compared to other currencies. Over extremely long periods of time, gold has performed well as a store-hold of wealth, particularly as interest rates in developed economies have fallen. This is because the opportunity cost of holding gold is the real interest rate available in fiat currencies. In 2020, global central banks cut their interest rates to near-zero levels, and as inflation began to creep up- gold was a desirable proposition. However, as growth began to rise and opportunities to invest elsewhere once again became viable, the demand for risk increases and the demand for safety reduces- hence, gold has seen a significant decline from its all-time highs. If reflation continues, gold will likely remain unloved and vice-versa.

Today’s FOMC will largely be focused on the economic outlook of committee members. Particularly, we should be looking for changes to the Summary of Economic Projections (SEP). Markets are awaiting this information as it will likely inform the Fed’s reaction function to economic improvement. However, it probably makes sense to look past the immediate term and realize that the Fed is boxed in by its objectives of maximum employment, i.e. until unemployment improves they cannot move interest rates. Further, there are likely to be a lot of questions surrounding the recent bond sell-off in order to assess the Fed’s tolerance of this move. So for Chair Powell has been steadfast in his commitment to looking past “transitory inflation”, but markets will likely be looking for reassurance.

Going into tomorrow’s FOMC meeting, we look at our panel of trading indicators for GBPUSD. They include:

• Trading Range: These ranges represent a trading bank within which a currency should trade based on multiple market factors. If we are long- prices above the upside range indicate the asset is expensive, and prices below the downside range suggest that they are cheap and vice versa if we are short.
• Year-to-Date Returns: This is the price performance of a given currency over the course of the current calendar year, in percentage terms. We also compare the current price to the 52-week high and low for reference.
• Price Momentum: This looks at cumulative rolling returns for a selected lookback period.  Positive momentum is good if we are long and bad if we are short. 
• Implied Volatility Discount/Premium: This tells us what the market expects in terms of volatility relative to the history of volatility. If we are long a currency, we typically want market implied volatility to be higher than historical volatility and vice versa if we are short.

Going into tomorrow’s FOMC meeting, the GBPUSD looks a little expensive due to a recent jump. However, fundamental trends, medium-term momentum, and volatility seem to favor GBPUSD. The shorter-term indicators aren’t as positive- particularly our trading range and price relative to their 52-week highs. An ideal situation for entry is when all of these signals align, so while GBPUSD probably has upside, all our signals are yet to be triggered.

US Retail Sales came in weaker than expected today. However, the trend remains positive on a year-over-year basis. The slowdown is attributed to weaker demand due to the U.S. experienced sub-freezing temperatures and winter storms overwhelmed power grids in Texas and the Great Plains.

This comes when the US equity market is continuing to make all-time highs, though price action looks overdone relative to our risk ranges. Looking forward, retail sales are likely to improve significantly as stimulus checks from the government are sent out, bolstering demand. Overall, while the print is disappointing, the outlook is still positive.

The upcoming FOMC meeting on Wednesday will most likely be focused on term interest rates. Long-term rates in the US have been rising immensely due to rising inflation expectations as the economy rebounds from the pandemic recession. The question ahead of this FOMC meeting is how much long-term interest rate increases can the Fed tolerate?

The Fed has largely said it would be patient about inflation, so we think there is potential for the Fed to allow these moves to continue. After all, interest rates are still not at 2019 highs. If long-term rates continue to sell-off the way they have, the broad dollar should continue its bounce, particularly against EURUSD. There is evidence that even if the Fed decides to control long-term rates by increasing their asset purchases, EURUSD will continue to fall. Here’s a chart from Nordea showing EURUSD during QE and “Operation-Twist”- a program the Fed engaged in to bring down long-term rates.

People often compare the price of a stock relative to its earnings. Today, we think it makes more sense to compare stocks to the amount of money outstanding that can purchase it- i.e., we don’t think there’s a bubble (yet)!

US CPI once again came in at 1.4%, far from market expectations of a booming inflation environment. In fact, median CPI was actually negative!