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However, the Fed does not think so, at least from what Chairperson Janet Yellen said in her semi-annual monetary policy report to the Congress.
Therefore, relative to market expectations, the Fed is still somewhat more hawkish, as Yellen believed gradual adjustments to monetary policy are still warranted. Her optimism is reflected in her assessment of the current economic situation and outlook. Overall, the labour market has shown solid gains, and while inflation is expected to stay low in the near term, partially due to weakness in oil prices, the Fed is confident that inflation will rise to its 2% objective over the medium term. In that regard, a rate hike in March is still very much in the realm of possibility, although it seems unlikely in my view, particularly if the volatility in the financial markets continues.
It was not all rosy in Yellen’s eyes. She acknowledged that financial conditions in the US have tightened recently due to declines in the equity market, higher borrowing costs and a stronger dollar. Furthermore, if these developments persist, it could dim the prospects of economic growth and job gains. More importantly, the Fed remains data-dependent when it comes to setting interest rates. It means that if economic activity picks up quicker than expected and/or inflation accelerates rapidly, the Fed will deem it appropriate to raise the federal funds rate more quickly as well. The converse holds true. If the economy disappoints, then a slower path of interest rates would be justified. It is also worthwhile to note that the stance of monetary policy remains accommodative as the federal funds rate is likely to stay below the levels that are expected to prevail in the longer term.
How did the markets take to the testimony?
The initial reaction was to buy dollar on perceived hawkishness from the Fed. The dollar index rose over half a percentage point to around 96.70 after Yellen started speaking, however the gains were more than erased subsequently, as more investors believed that the Fed may be forced to shelf rate hike plans should market volatility persist. Truth to be told, the Fed testimony did not reveal much that we do not already know. What it does seem to say is that market volatility is a major consideration, especially when paired with weak economic activity and inflation growth. Meanwhile, de-risking intentions have seen the Japanese yen gaining rapidly, which are raising concerns. The USD/JPY has gained around 6% year to date, rising to low 113 versus the dollar, from 120 at the end of last year. The risk of direct intervention from the BOJ or further easing has increased with the stronger yen. Investors should be mindful of these possibilities.
- Equity performance in the overnight market was somewhat mixed. European indices were in an upbeat mood, finally rebounding after a number of declines in previous sessions. Stoxx Europe 600 rose +1.9%, snapping six straight days of losses. The rally was led by gains in banks, with Deutsche Bank jumping +4.6%. US equities were unimpressive. S&P500 closed flat, while the Dow dropped -0.6%.
- A one-two combination lifted gold prices. USD retreat and haven demand pushed gold over $1200, hitting the highest in eight months at $1204.53 in early Asia.
- US treasuries kept pace with rising expectations that the Fed will not proceed with rate hikes this year. 10-year yields continued to fall, dropping below 1.70, to the lowest in over a year. According to the fed funds futures markets, the probability of at least one rate increase in 2016 has fallen to 30%.
*For more timely quips, you may wish to follow me on twitter at https://twitter.com/BernardAw_IG