Fed sends clear dovish message

If the Fed wanted to send a dovish message to the market then they should get full marks, and they communicated that quite effectively.

Traders on the other hand are perhaps a little less enthused about the divergence between recent market expectations around this FOMC meeting and what actually transpired. Although there were traders positioned for no tapering, it seems few were positioned for the extent of their dovish stance in the narrative and projections.

USD bulls have reverted to the sidelines and while a lot of fast money traders have exited USD longs and equity shorts, the risk is the more investment focused (longer-term) money managers will follow closely behind. The Fed had a chance to taper and chose not to, and clearly the issue is around fiscal constraints, although the fact payrolls have averaged 136,500 in Q3 is a concern, especially as the trend is down, with the print averaging some 25% below Q2 and 34% below Q1. The threshold for an increase in the Fed funds rate was not altered from the current stance of 6.5%, however it may as well have been, given the bank said they wouldn’t move until the unemployment trades ‘considerably’ below 6.5%; and we feel this point is key.

We are a touch confused that the Fed warned about the ‘tightening of financial conditions observed in recent months’, given the S&P 500 was a whisper from its all-time high and the market snapped up Verizon’s $49 billion bond issuance with ease. It makes sense therefore to think they are singling out the bond market and clearly this market felt it in full force, falling to 2.67% (down nineteen basis points) and testing the former downtrend from 2007. A look at the Fed fund futures shows the market is now pricing in 54 basis points of tightening by June 2015, down from 65 basis points yesterday. Given their point about financial conditions being tight and the Fed’s focus on the bond market, we get the sense that follow through buying, resulting in a move below 2.5%, could actually work in favour of tapering. In saying this, we will need to see a pick-up in the hiring trends and a rise in the actual quality given the participation rate is currently at the lowest levels since 1978.

Fed gives green light to bid up stocks

The end result of the meeting though is a green light to bid up stocks even further, although we are getting to overbought levels with around 80% of S&P stocks above their 50-day moving average. Around a quarter of the top 500 companies in the US are at 52-week highs, although this can obviously increase. In the FX space, the USD has re-joined the JPY as the markets preferred funding currency for the carry trade and in a world where we are seeing growing divergence between central bank views, pullbacks in GBP/USD, AUD/USD and NZD/USD should be bought. Emerging market bonds, currencies and indices are naturally rejoicing at the Fed keeping the balance sheet expansion constant; with the Indonesia market up 4.5%, while the Bombay sensex is up 2.8%.

More developed Asian equities are finding solid buying, although China is closed for mid-Autumn festival and will remain so tomorrow. You know things are positive when Japan rallies 1.25%, despite USD/JPY trading down to 97.76. Traders have modestly covered shorts, with the pair pushing up towards the 50-day moving average at 98.65. There are a number of central banks which warrant significant attention going forward, with the ECB and RBA and (to a lesser degree) BoJ, RBNZ and BoE the one’s we are most interested in, given they have all recently talked about currency strength. With EUR/USD above 1.35 and AUD/USD around 0.95 the prospect of currency fighting narrative should increase in the coming months. During trade today we heard from BoJ member Takahide Kiuchi, although he didn’t say anything worthy of note about US monetary policy, with his comments focusing on domestic issues. Worryingly, he mentioned that he sees bigger downside risks to the economy than upside, but countered it by saying the bank may be forced to increase stimulus under its current policy. BoJ head Haruhiko Kuroda speaks at 18:30 AEST, so this is worth paying attention to.

Aussie market rallies

The ASX 200 has rallied 1%, although couldn’t quite break through 5300. The materials sector has rallied a sizeable 2.3%, with the industrial and energy sectors doing nicely, as you’d imagine, given the positive sentiment in risk. Gold was probably the star overnight, with a 4% rally. Newcrest Mining is up 7% and continues to hold the June uptrend and while my equities colleague Evan Lucas feels fundamentally there are better names to own, we would stay long here until the trend breaks. Expect London and European miners to replicate these moves today.

European equities are in for a solid start, with 1% gains seen across the different markets. European bond markets should drop sharply on open, given the strong moves lower in the US ten-year treasury and Asian bond markets (Australian ten-year down nineteen basis points) and it will be interesting to view these bond yield spreads over US treasuries. Data will focus on UK retail sales ex auto’s (expected to be unchanged), while the US weekly jobless claims are also due out and are expected to tick up slightly to 330,000. Otherwise we have firm break-outs in the DAX, CAC, MIB and IBEX, with the FTSE looking a little less positive. Stay long on these markets, as momentum favours continued strength.


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