The January FOMC – Goldman’s Take from Traders and Research FICC and Equities | January 2025 |

We are looking for a less eventful FOMC meeting tomorrow and not expecting significant new insights or surprises. Powell’s press conference will offer more room for variance, and we will be watching in particular how he responds to inevitable questions on: 1) How the Committee will navigate the risks posed by tariffs, and in particular how they intend on framing the inflation discussion in response to a one-time price shock 2) Central bank independence under the Trump administration and 3) The restrictiveness of policy rates, and how opinions on this front are divided within the committee. We view risks over the meeting as skewed to a dovish reaction, and remain biased to long expressions targeted on 2025 year-end rates.

GS Trading/Strategy

FX

The key question for this meeting is whether the FOMC considers current rates "meaningfully restrictive." This assessment will determine the Fed's response to unexpected labour market weakening or financial tightening following an equity market slump. In FX, tariff estimates have reduced Dollar support. We ascribe EUR/USD's slide from 1.12 to 1.05 to rate differentials, but inflated tariff projections contributed significantly. Two-thirds of the tariff premium has fallen, consistent with a position recalibration but possibly overshooting underlying shifts. The Fed could convince the market that recent policy rate adjustments were too aggressive, creating downside risk as expectations are evaluated. The question is whether the Dollar can fall with US equities. While some occurrences may align, the 2023 SVB dynamics were clear in swapping monetary tightening for credit constraint and a currency consequence. After initially targeting JPY, CHF, and EUR, the Dollar depreciated higher beta currencies as the market priced in a more lenient Fed. Current market trends are different. Despite strong asset performances supporting the Dollar, this support should be regarded in a comparative context, meaning that a widespread Dollar fall is unlikely unless the Fed tightens policy.

In case of tariff letdown, we indicated 1.07/08 in EURUSD and 7.20/25 in USDCNH last week. While we have achieved the latter, we are still fighting to achieve the former, since positioning is becoming more neutral. Both levels indicate potential re-entry points for USD strength. After a dovish and conciliatory DT this week, a tactical strategy is needed. While catalysts for a USD cycle high retest may not occur until Q2, I remain optimistic. Considering the elevated risk to Canada and Mexico, I recommend positioning for USD topside in both on a 3-month horizon. However, February 1 is now a larger event than expected. While we support JPY this year, recent price action in USD/JPY confirms our concerns about consensus. USDJPY barely changed despite BOJ hike and DXY selling off 150bp. We recommend waiting for a return to 158+ before shorting USD.

Equities ( Wednesday’s expected move in SPX is +/- 1.05%.)

Policy News & Tech Earnings to Drive Market Focus: Forecasts indicate that the Fed will likely maintain the policy rate at this meeting, with a projected further 50 basis point cut anticipated later in the year. Anticipation surrounds the Fed meeting, with expectations of a status quo holding already fully priced in by the market. Speculation also points towards approximately 50 basis points of cuts remaining in the Fed's reduction cycle. Given the positive state of the labor market, attention will likely shift towards the assessment of the restrictiveness of the funds rate at its current levels and the potential impacts of tariffs. The Fed may refrain from divulging significant new details until more information is available on inflation trends and broader policy trajectories. reactions following the previous FOMC and employment data have been tempered by recent CPI releases and a lack of immediate tariff actions. Despite pricing in indications of robust growth, concerns about inflation risks persist. The prevailing sentiment suggests that the market might be overestimating rate hike risks this year while underestimating the probable trajectory. Consequently, front-end rate receivers are considered potential hedges against potential growth uncertainties. As fears of inflation-driven Fed actions ease, this could bode well for risk assets, signaling an opportune time to capitalize on affordable optionality.

While the Fed's tone in December hinted at a more hawkish stance, any softening in the upcoming meeting could continue the recent trend of decreased Fed hawkishness. However, the market landscape is expected to be shaped significantly by policy news from the new administration and tech earnings in the days and weeks to come. The lead-up to the March FOMC meeting is touted to have a more significant impact on markets.

In equities, recent setbacks were observed as US tech stocks were rattled by news of DeepSeek's AI model, culminating in the S&P 500 finishing down by 1.4% and the Nasdaq finishing at a 2.9% decline. Despite considerable market movements, volatility and skew exhibited notable bids without exorbitant reactions compared to the substantial spot price shifts. This subdued volatility response indicates an oversaturation in volatility positioning, with dealers holding ample options from systematic sellers, thus mitigating the necessity to acquire convexity amid pronounced market shifts. Given this scenario, holding options heading into the Fed meeting is favored as the expectation is for these options to carry value effectively.