Before the US central bank announced its decision to enact its program to start winding down its balance sheet and indicated its intention to still pursue another rate hike before the year was done, the market had drawn in a deep and collective breath.
The five-day average true range (ATR) for the S&P 500 had hit extreme lows only comparable to holiday conditions back to 1996. The VIX volatility index in the meantime slid into its much maligned (by traders) 10 level. Now, after the hawkish update, investors have to add this consideration to concerns of protectionism, North Korean aggression, Chinese growth and other prominent themes conflicting with the persistence of complacency.
Wall Street: If we simply looked at the daily change statistics through the New York close, it would seem as if nothing material had happened this past session. The Nasdaq’s 0.1 percent decline was the worst performance amongst the major indices with both the Dow Jones Industrial Average and S&P 500 slightly higher over Tuesday’s close. In reality, the fundamental developments this past session will likely resonate and undermine equities (US and global) for some time going forward.
The US benchmarks are at record highs and their climb continues to pull further away from traditional corporate, economic and financial valuations. That is sustainable so long as speculation remains charged. But crucial in speculation that is chasing returns, there must be little or no threat of volatility. And, dependence on that is an inevitable recipe for disaster. Take advantage of momentum, but don’t follow along blindly with infrequent reviews of your account.
Fed Keeps Its Hawkish Lean: The market has progressively lowered its expectations for the Federal Reserve’s monetary policy path moving forward. With persistently underwhelming inflation data and the central bank’s commitment to be transparent (which also seems to mean not countering speculation), the market was given free rein to cut down the past years’ rate expectations. Yet, it is this skepticism that leveraged the market impact of the central bank’s reiteration of its commitment.
Though the Fed held rates at Wednesday’s meeting, their Summary of Economic Projections (SEP) showed that the group still expects to hike again this year – leaving only the meeting on November 1 or December 13 to act. Given the evidence touted for how impossible that was and the short time frame that can happen in, it is going to be difficult for the market to keep a discount to the Fed’s view. That is a boon for the Dollar. The other important development from the meeting was the announcement that the QE reduction plan laid out in the June policy meeting would actually start in October.
This is the first major central bank that pursued QE that will officially reduce its stimulus effort. While the S&P 500 and its peers didn’t show much fear immediately after the news, make no mistake; the extreme reach for risk over the past months and years is fully dependent on central banks’ complicity. Its withdrawal will take a toll.
Bank of Japan Will Play the Counterpart: The Bank of Japan is (BoJ) is the other major central bank due to weigh in on policy this week. However, there is no material change expected from this group on either rates or its stimulus program. However, the Japanese central bank plays a critical role in global finance. As a host of other central banks are earning growing speculation of impending tightening, the tenacious dove acts as the anchor for assessing global monetary policy’s support of the world economy and financial system. If this surprise-prone central bank were to indicate it too would start to moderate its efforts, it could singlehandedly undermine one of the pillars of risk taking this decade.
More Monetary Policy Speculation in Leaders’ Speeches: While the Fed and BoJ (along the less market-moving Norges Bank) are the only major central bank decisions on the docket this week, there are plenty of speeches scheduled by particularly important policy officials through the second half of this week. In addition to BoJ Kuroda’s after-decision remarks today, we have RBA Governor Lowe on tap. ECB President Mario Draghi, who is grappling with a market that is aggressively speculating on an eventual change in course that has lifted the Euro, is set to speak on Thursday and Friday. And, on Friday, Fed members Williams, George and Kaplan will be closely observed for post-meeting bias.
Australia Dollar: With the exception of the New Zealand Dollar, the Aussie Dollar was the best performer amongst the majors this past session. Most remarkable was the consistent gains registered against the trinity of liquid counterparts: AUD/USD, EUR/AUD and AUD/JPY. Though AUD/USD gave up a significant amount of its intraday gains through this past session’s close, it still managed a close in the green. However, confidence in a recharged bull is tough to secure given the tails at highs these past two months. EUR/AUD’s sharp break lower Wednesday was a large move, but moves into established range. AUD/JPY on the other hand cleared its upper bound to trade at multi-year highs. Bull or bear on that pair, remain cautious of the support from risk appetite necessary to keep it rising.
ASX: Looking to futures, the ASX is reportedly looking to open with a slight boost Thursday morning. That said, risk trends are not clear following the world’s largest central bank’s decision to withdrawal its support of the system. While the outlook for higher yields to be earned by banks, we may see some sympathy gains through RBA forecasts and further Aussie banks’ returns. However, that outlook will not compensate the broad market should doubt seep in.
Commodities: There was little mistaking gold’s take on the hawkish tone from the US central bank. It was discouraging. This precious metal is many things – an inflation hedge, a safe haven in risk aversion and sometimes dramatically an alternative to traditional fiat currency. That said, price pressures have been subdued, speculators seem oblivious to risks and the Dollar is championing a withdrawal of the policy that has deflated currencies the world over.
S&P/ASX 200 down 4.486 points or -0.07% to 5709.091
AUD +0.23% to 0.8029 US cents
On Wall St, Dow +0.19%, S&P 500 +0.06%, Nasdaq -0.08%
In New York, BHP -0.42%, Rio -1.30%
In Europe, Stoxx 50 -0.16%, FTSE -0.05%, CAC +0.08%, DAX +0.06%
Spot gold -0.88% at US$1299.67 an ounce
Brent crude +1.87 % to US$56.16 a barrel
Iron ore -2.93% to US$75.425 a tonne
Dalian iron ore at 491.0 yuan
LME aluminium (cash) +1.72% to $US2095.75 a tonne
LME copper (cash) +0.22% to US$6488.25 a tonne
10-year bond yield: US 2.27%, Germany 0.44%, Australia 2.83%
By John Kicklighter, Chief Strategist, IG Chicago