Returning to basics as Fed holds the line

‘No taper’ - and there was much rejoicing.

Markets as you would expect took the news to hold the line on the current accommodative programme as positive news and jumped to all-time intraday and closing highs.

The most interesting line out of Chairman Bernanke’s speech is the return to the original mantra for quantitative easing – unemployment is too high and inflation is too low.

We have been wary of the unevenness of the data coming out over the last two months particularly. The official non-farm payrolls, ADP non-farm payrolls and the ISM manufacturing PMI’s employment component all show varying ranges of participation levels and employment changes; unemployment claims are erratic and data stream disjointed.

The statement also looks like the Fed has stepped back from the taper edge the timeline for the removal of quantitative easing has now become fluid the mid-2014 line has been removed. The fed funds rate may not rise till well into FY16 after Bernanke stated that the unemployment rate ‘may need to be considerably lower’ than the current target of 6.5%, and inflation is well below target figures of 2.5% meaning accommodative policy should remain.

These comments are all understandable from the point of view that the Fed is concerned about the considerable rise in the mortgage rates, having seen the bond market jump a full 1% before the announcement to touch 3% last week; seeing the average interest rate on a US 30-year mortgage at 4.57%. Sequester has also been implanted even though politicians never meant for it to be written into law.

Bernanke is also acutely aware that Washington is again playing politics with the debt ceiling and if negotiations of 2011 are anything to go by, expect to see threats of shutting down the government and defaulting on repayments – in short, any economic recovery seen this year is under a cloud of uncertainty from the current configuration of the Senate.

All of this culminated into the hold the line call and as you would expect, the risk on trade was switched on -‘bad news is good news’.

The movement in the bond markets was immense; the US ten-year treasuries dropped 15 basis points to 2.75% and saw the USD tanking, the Fed fund futures also dropped nine basis points to 54 basis point hike in June 15 from 65 basis points yesterday.

All major pairs with the USD are running hot, with AUD/USD the strongest performer up 1.8% in the US session and EUR/USD not far behind. This does raise the question, what will be the responses from other central banks?

The RBA has made it clear over the last year that the AUD is high – will today’s developments see it actively talking down the AUD, as it is now too high? Will it look to mechanisms that it could use to pull the AUD, to again see it moving away from parity?

It also raises questions about the Bank of Japan. The fall in the USD is dire to its stimulus plans for the yen and the broader Japanese economy. Will the Bank have to intervene again? Will the three arrows be ramped up?

There are more questions out of this morning’s announcements than answers - strategist, analysts and commentators alike are questioning the Fed’s communication – or lack of it.

Ahead of the open we are now calling the ASX 200 up 65 points to 5303 (+1.24%), today could be the first time in five and a half years the ASX has been above 5300 points. Today will also see the very strong inverse correlation between the Nikkei and the yen broken. Both will appreciate but again, it will rise questions as to how is will be sustained.

As you would expect, BHP’s ADR is suggesting the stock will move higher, up 66 cents to $36.75, and could very well pop into the $37 handle. The risk on trade will move to gold stock after gold had its eleventh strongest day ever since 1990, while energy stock will be buoyed by the jump in oil.

The clearest theme to come out of this morning’s news is this: upside volatility is coming in the short term, downside volatility is now a medium term prospect. 

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