Notes from the FOMC

‘Expect the unexpected’ is normally a good mantra as to how markets move leading into a central bank announcement. This morning’s FOMC statement was so widely expected to be scripted that the market was running into it with open arms, and may even have got slightly ahead of itself.

Fed
Source: Bloomberg

However, as with all central bank meetings, the devil is in the details – some would argue the market is dancing at shadows. There is certainly a general conclusion the statement has an element of hawkishness that wasn’t anticipated.

Key points:

The labour market outlook – This was the biggest change in the statement. The committee adjusted its view on the labour market, rewording its statement to ‘underutilisation of labour resources is gradually diminishing’, which replaced the significantly move dovish language of ‘significant underutilisation’. This is probably the clearest hawkish sign from the announcement. The board also described job creation as ‘solid’. Considering the non-farm payroll average is now well above 200,000, solid may even be modest.

Inflation - In the short term, it possibly went the other way from employment. The committee noted that inflation ‘in the near term will likely be held down by lower energy prices’. However, they continued to hold the line, saying persistent lower-than-estimated inflation risk has ‘diminished somewhat since early this year’. That would imply estimates of 1.6%-1.9% in 2015 are still very much in play. The inflation outlook also saw a shift in dissenting voters. The two dissenting hawks in Plosser and Richard Fisher voted with the board, while the dovish voter Kocherlakota dissented, stating the Fed funds range shouldn’t increase until the one-to-two year inflation outlook returns to 2%. As it’s sitting around 94 basis points, he has a point.

QE - Ended. There were no shocks here and, considering the dual mandate commendatory above, any thoughts the market may have had that Jamie Bullard’s recent comments would come to fruition were shot down immediately. The question now is whether after six years, three QEs and US$4 trillion, has it worked? Equity markets would suggest it has but what are the longer-lasting effects? The jury is out on that one, particularly as central bank theory 101 states that easy policy will create inflation – this was Kocherlakota’s point.

‘Considerable Time’ – This remained, and was not changed in any significant manner. Language around ‘data-dependency’ mirrored that of the statements coming from Chairperson Yellen’s past statements. There was no mention of global growth fears or market volatility.

The most interesting development here was the movements in the bond market. Front-end rates moved solidly higher. US two-year bonds added five basis points in their tenth biggest intraday move since 2009. There has also been a shift in the swaps markets as they’ve sharpened their belief rates will move higher in the second quarter of next year. This is all hawkish in the short term and something for equity markets to ponder.

Ahead of the Australian open

Trade in the ASX yesterday was very interesting. There was a third rejection of the 61.8% retracement of the recent pullback, enforcing my view the ASX is probably range bound between 5350 and 5500 for the next six to eight weeks as banks turn ex-dividend and the AUD comes back into play.

We’re currently calling the ASX 200 down seven points to 5440. Considering commodities were mixed and NAB is releasing pre-known data, there isn’t any major driver, leaving the ASX to ponder how a full day’s trade in the US will react to the Fed numbers. The USD is likely to turn to the winners circle over the coming week after having a breather. AUD, EUR and JPY are likely to see selling. Equity-wise, we may see a further rejection of the 61.8% retracement.

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