“Finally”, this was the most common word heard yesterday as the Federal Reserve pulled the trigger on what promised to be done two years ago, ending 7 years of zero interest rates era.
The fed’s first-rate hike in almost a decade was met by warm greetings in Asian trade today, suggesting that Yellen and her team were successful in convincing markets that hiking rates is the right thing to do after preparing markets for so long and the U.S. economic growth projections look solid.
Emerging markets were expected to be hit the most, with many economists forecasting huge capital outflows escaping to developed economies. Although it is too soon to judge the implications of U.S. tightening on the long run, the initial reaction was positive and risk appetite drove all major indices higher. European markets also set to resume a three days rally.
The target range of the Fed Funds rate was raised by 25 basis points to set at 0.25% - 0.50%. As expected the accompanying statement stressed that the future path will be “gradual” and given the current shortfall in inflation compared with its 2% target, it would carefully monitor actual and expected progress towards its inflation goal. However, looking at the overall picture, the Fed wasn’t as dovish as economists anticipated and here’s why:
- No Dissents: Chicago Fed President Charles Evans, Governor Lael Brainard, and Governor Daniel Tarullo were all expected to oppose a rate hike. In fact all voted along with other Fed member towards a rate hike signalling to the markets that they are on strong footings.
- Dot Chart: Although lowering slightly the projections for 2017 and 2018 rate levels. 2016 remained the same, indicating four possible rate hike, while markets are only looking for 2.5.
- Oil Prices: Yellen not worried about the drop in oil, arguing that it won’t drag down underlying inflation in the U.S. economy
The USD traded range bound at most of yesterday’s event, and this is the best-case scenario for the Federal Reserve, keeping volatility under control with decision as such. However, as traders digested all the information, the U.S. currency started inching slightly higher and so as the yields along the US yield curve. Our mid – long term view on the USD continue to be bullish and EURUSD parity discussion not necessarily over, but with many options due to expire some volatility could be experienced, selling the rallies on EURUSD is likely to be the strategy going towards Q1 2016.
The USDJPY also traded higher for the fourth consecutive day after testing 120.32 on Monday. The BoJ is meeting tomorrow for the final time this year and for the first time since 2005 the Japanese central bank looks set to get through a year without a change in monetary policy. Governor Haruhiko Kuroda has not shown interest in increasing asset purchase program recently and we do not expect him to surprise us either tomorrow. The currency pair likely to continue trading sideways for the reminder of the year in the range of 120 – 124.
Tier two economic data from the Eurozone, UK, and US on the radar with little impact expected on currencies. German IFO expectations anticipated to improve to 105.0 in December from 104.7, while UK retail sales expected to recover from October’s slump ahead of the holiday’s season, whereas on the U.S. docket will be looking for Current Account, Jobless Claims, and Philadelphia Fed Manufacturing Survey.