Over the last 5-6 years, a clear relationship had been built between the Fed and markets. Dovish Fed news was seen as good for liquidity and stimulus, sending stocks higher and USD lower on increased money supply. News seen as hawkish for the Fed had the opposite effect.
The reaction to yesterday’s FOMC news, however, shows that this relationship has completely broken down.
To recap, the Fed did not raise interest rates, but it did increase GDP and employment forecasts (lower unemployment rate). There was one hawkish dissenter, but the dot plot of Fed funds projections took a dovish turn with one member calling for negative interest rates and the number of members looking for liftoff this year falling to 15 from 13.
Fed Chair Yellen’s press conference also indicated that the Fed remains on track to raise rates this year. Some of the highlights include:
The Fed continues to monitor overseas developments, particularly related to China.
Labour market is tightening
Inflation downdraft from oil crash transitory
Every meeting is live for a potential rate hike. She indicated that if they move in October, a press conference could be called on short notice.
Indicated the Fed is not considering negative interest rates (which makes the dot plot look even more like an outlier)
Downplayed influence of a possible government shutdown on decision making in answer to a question (ie no prepared comments). Even if it did, the Fed would never say so because they need to be seen as independent of politics
Market reaction to this news has been very mixed:
USD moved sharply lower in response. The big rally in the greenback over the last year not only priced in a first hike, but also a campaign of increases like we saw last cycle. Yesterday’s news reminded traders that no matter when the Fed gets around to raising rates the path is likely to be slow, more like one and done for a while. This drop has sparked big rallies in gold, and other major currencies, particularly but not limited to NZD, AUD, CHF and JPY. The only major up less than 1% on USD today is GBP, and this is likely because Sterling had already moved up quite a bit this week.
Commodities and stocks have also been smashed, however, the opposite of what happened a year ago when the Fed floated the idea of QE4. This is likely due to the negative signalling effect I mentioned in my FOMC preview. That is, by holding off, the Fed has many traders asking what they are seeing that spooked them into waiting longer? Concern appears to be particularly focuses on China and worry that a weaker Chinese economy could translate into lower resource demand has driven oil and copper down again today.
I think, however, that the ultra-dovish read on the Fed has been overdone, and that yesterday’s developments keep the Fed on track toward raising rates this year. I’ve been saying through the year that the Fed would likely not spring liftoff on the market, that it would signal through increases in its economic forecasts and hawkish dissent which is what we saw yesterday.
I also have been saying that a move toward liftoff would be accompanied by dovish rhetoric, which we also saw yesterday. Talk about negative interest rates I think are a red herring and may have gone too far, which is why Chair Yellen backed away from it later.
We’re only a few weeks out from a lot of market turbulence in China and only a few weeks away from a possible US government shutdown. Recall the risk of a shutdown in 2013 caused the Fed to delay tapering from September to December. Since there are still too more meetings this year, the Fed had room to wait a bit to get a better lay of the land.
Interestingly, Chinese stock markets are among the few that are up overnight, still indicating that the worst has likely passed. A month from now this should have all blown over, clearing the way for the Fed to raise rates in October, leaving December as a backup possibility if overseas uncertainty continues.
Historically, US stocks have underperformed in the month before and the month after an initial rate hike, then rallied as US economic strength took centre stage. The biggest potential impact of the Fed’s decision to wait appears to be that by dragging out uncertainty over when liftoff may occur, world markets could remain volatile and extra sensitive to data for several weeks to come, an environment that favours short-term swing
and news trading strategies over long-term investing.
Adobe Systems $0.54 vs street $0.50, guides next Q sales to $1.275 to $1.325B below street $1.360B
Significant announcements released overnight include:
US interest rate 0.25% no change as expected
US FOMC member forecast changes
2015 GDP raised to 2.1% from 1.9%
2016 GDP cut to 2.3% from 2.5%
2015 unemployment rate lowered to 5.0% from 5.3%
2016 unemployment rate lowered to 4.8% from 5.1%
2015 core PCE inflation raised to 1.4% from 1.3%
2016 core PCE inflation lowered to 1.7% from 1.8%
Dot plots of FOMC Fed Funds projections
12 members between 0.25% and 0.75% (1-2 increases)
3 members between 0% and 0.25% (no change to rates this year)
1 member projecting negative rates (most likely Kocherlakota a non-voter this year)
1 member projecting 0.75%-1.0% (2 increases one of at least 0.50%)
13 members looking for liftoff this year, 2 in 2016 and 1 in 2017 vs June when 15 were thinking 2015 and 2 2016, a bit dovish at the margins.
NZ ANZ consumer confidence previous 109.8
Canada consumer prices street 1.3%
Canada core CPI street 2.1% vs previous 2.4%
Upcoming significant announcements include:
9:00 am EDT China senior officials speech “Renminbi internationalization in volatile markets” in Washington, DC
10:00 am EDT US leading index street 0.2%
1:00 pm EDT US Baker Hughes drill rig count previous 848
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Saturday FOMC members Bullard and Williams speaking