Fed's dovish taper is a hawkish surprise

The market finally got its wish from September for a dovish token taper of $10 billion split evenly over mortgage-backed securities and treasuries. 

This means from January 2014 the Fed will buy the two debt instruments at $75 billion a month, rather than $85 billion.

This can be taken as a slight hawkish surprise as only a third of economist surveyed predicted December would be the start of taper. The other reason for a hawkish call is the dissenting vote shifted from the hawks to the doves for the first time since QE1.

The most hawkish voting member on the FOMC is Kansas President Esther George, and for the first time this year as a voting member she didn’t dissent. While on the other side of the ledger, the biggest voting dove on the board Boston President Eric Rosengren dissented from voting for the first time as the hawks finally got their way.

The expectation now is that if the labour market continues to show solid signs of improvement, and inflation doesn’t unexpectedly drop out,  then the inferred meaning drawn from this statement: ’will likely reduce the pace of asset purchases in further measured steps at future meetings,’ would suggests that by October 2014 the monetary part of the QE stimulus program will be completely unwound.

However, there were several enhancements in forward guidance in the fund rate, which should be supportive and are dovish in nature. The key summary statement for the Fed funds rate is this:

"The Committee now anticipates, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6.5%, especially if projected inflation continues to run below the Committee's 2% long-run goal. When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2%."

This shows the clear disassociation (something it has been good at communicating) between the unwinding of stimulus and monetary tightening. The statement above suggests that even if employment drops to the 6.5% threshold, the forward guidance suggests that it won’t necessarily trigger a move in the Fed funds rate as unemployment is expected to hit 6.2% this time next year, and it may be the case that monetary stimulus is still in the market if the unwinding isn’t uniformed.

So, despite the fact unemployment is now expected to be 6.2% in December 2014, over two thirds of the board believe the first tightening measure will come in 2015, with some even calling 2016 as the first tightening move. The medium FOMC forecast for the Fed funds rate at the end of 2016 is 1.75%. 

This would explain why the flows desks have seen some classic moves post the announcement, with equities taking this in its stride, the Dow only two points from record highs, the USD strengthening, the JPY weakening (as did the AUD) and gold following suit. This suggests even with the ‘safety catch’ moving to off, the market is free to move higher.  

Ahead of the Australian open 

The news out of the US is a boost for the local equity market and a downward force on the local currency; both of which are net positives.

We are currently calling the ASX up 56 points to 5154 or 1.1% as the weakening dollar drives the cyclical stocks and the move from the Fed saw industrial metals and oil bounce, adding additional support.

BHP’s ADR is showing the positive leads from the US are flowing positively to the stock with the deposit receipt suggesting 72 cents could be added, taking BHP to $36.51 +2.01%. The green on screen should be universal, even with gold sliding.

This isn’t a Santa rally, but will finally add some much-needed support to a market that has lost 7% in the past eight weeks.

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