The Fed Dot Plot of the future rate trajectory saw projected rate hikes for 2016 drop to 2 from a previous 4, and real GDP to grow at 2.2% this year, 0.2% lower than their forecast in December. This was far more dovish than markets had expected, resulting in sharp rallies in commodities, emerging markets and commodity-related currencies. This has clearly hurt US financials, which were hoping for a steepening of yield curve, but the rest of the US markets have taken the news well and pushed into positive territory.
Asia is looking to open strongly in the wake of the Fed decision. The Aussie (+1.2%) and Kiwi (+1.8%) dollars have both rallied sharply in the wake of the decision and ahead of the release of New Zealand’s 4Q GDP and Australia’s February employment figures. If both economic releases beat estimates that is only going to put further gas behind the currencies strengthening moves. Iron ore added another 1.9% overnight, and BHP and CBA’s ADRs both gained over 2%, pointing to a strong day for the ASX.
The Fed decision is particularly bullish for Chinese markets, as corporates with heavy USD-denominated debt burdens (particularly Chinese property developers) will relish the USD weakness. But this also greatly eases FX outflow pressure on the Chinese central bank. If global central banks wanted to stave off a destabilising Chinese currency devaluation, they could hardly have planned a better reaction from the ECB, BOJ and the Fed. Euro and yen strength alongside US dollar weakness is likely to shrink Chinese capital outflows in March. While no explicit Plaza Accords II decision emerged from the G20 meeting in February, the major central banks do seem to have become far more attentive to the global repercussions of their monetary policies. And markets should welcome this development as it greatly lessens the need for an imminent devaluation of the CNY and the global deflationary impact it would have.
Market pricing for a June rate hike by the Fed dropped significantly in the wake of the release, with the WIRP probability for June dropping from 53.6% yesterday to 37.4% today. The Fed downplayed the recent economic improvement in the statement and also in their economic projections. This perhaps reflects their awareness of the global ramifications of Fed policy, arguably evident in the addition of this new sentence: “However, global economic and financial developments continue to pose risks”.
What is most surprising is the Fed’s very low expectations for the path of inflation. The Fed is forecasting Core PCE inflation to continue in a band of 1.4-1.7% for 2016, yet Core PCE inflation in January was already running at 1.7%, the upper end of that forecast. Janet Yellen mentioned in the press conference that she believes this inflation increase was primarily due to transitory factors and expects it to ease again. But this, in my view, is probably the greatest risk to the current interest rate trajectory and probably the key US data point to watch in the lead up to the June FOMC meeting. And one of the main factors that could upset this forecast is oil, which had a very strong performance overnight in the wake of the weekly DOE inventories release and weak USD.
Oil has been such a key input into equity market performance for the past couple of months that the big 5% jump in WTI overnight should be taken as a strong positive for markets today. The announcement from Qatar’s energy minister that oil exporting countries would be meeting in Doha on 17 April to talk about capping production helped provide some upside to the price. The Fed’s dovish statement and corresponding USD weakness also helped the price.
But the weekly US Department of Energy report was particularly strong. Crude oil inventories grew by 1.3 million barrels, less than the 3.2 million barrel consensus and gasoline inventories declined for the fourth week in a row. With the Baker Hughes crude oil drill rig count below 400 and at levels not seen since the GFC, the prospects for inventories to reach their cyclical peak over the next month or two appear to be growing. WTI is likely to break back over US$40 again in the lead up to this meeting in Doha, but if the oil price spends a significant period of time above $40, inventories could start to build again possibly leading to a nasty reversal.