Equities across the globe rallied in response to the meeting and I suspect this is to do with lift-off expectations being pushed out, a weaker greenback and of course less uncertainty/caution around the Fed. Very few would have predicted the sharp move in the USD (particularly lower) on the back of the Fed meeting which resulted in significant short covering.
The highlight was the removal of the ‘patience’ reference of which many would have expected this to result in a stronger greenback. However, what made the difference was a substantial downgrade to interest rate forecasts in the dot plot analysis. The dots showed the median projection for the Fed funds target range is now at 0.63% (down from 1.13%) for the end of 2015 and now stands at 1.88% (down from 2.38%) for the end of 2016. For the end of 2017 it was lowered to 3.13% (from 3.63%).
Despite the removal of the patience reference, the Fed reinforced it would like to see further improvement in the labour market and wants to be reasonably confident inflation will move back to its 2% objective before lift-off. This sparked a rally in the treasury market, compressing yields and weakening the greenback. Bottom-line though, it’s clear rates are now data-dependant and every meeting will be assessing any progress in data. Essentially this also gives the Fed significant flexibility going forward to react to data as opposed to shackling itself with a timeline reference.
Lift-off pushed out?
The next meetings will be April and June, with no meeting in May. As a result it seems Q3 is now more likely to deliver a hike. Potentially September will be when the Fed might be comfortable enough to hike, but the market is pricing in lift-off in October. There are a couple of things the Fed seems to be worried about here, namely wage growth and the stronger US dollar impacting exports growth. However, given the strong improvement we’ve seen in the labour market, one wonders how much longer wage growth can be held back.
Fresh concerns for the RBA
With the Fed providing another put for global markets, a few themes have re-emerged in today’s trade. Firstly, yield is back in play and this has been a dominant force behind the ASX 200’s rally today. The banks have been the pinnacle of today’s performance along with other high yielding stocks. At the same time, growth/risk stocks have also enjoyed some bargain hunting with reduced risk of a capital flight from emerging markets.
A weaker US dollar also tends to be a positive for commodities and other risk assets. This has seen even iron ore miners rise despite weaker iron ore prices. An interesting dynamic has also emerged for Australia in that it could have an impact on when the RBA decides to cut again. The simple reasoning behind this is that a stronger AUD/USD cross rate as the greenback weakness would be undesirable. However, given the RBA looks at the currency from a trade-weighted basis, then this could be a stretch. Regardless, the chance of an April cut has now risen to 46.8%. Remember most analysts feel May is the most likely timing for further easing.
DAX pointing lower
Ahead of the European open we are calling the major bourses firmer with the exception of the DAX. Given the euro reversed significantly higher against the greenback, naturally the DAX would be on the back foot given the high correlation of the two.
EUR/USD reversed from around 1.0500 and even managed to trade through 1.1000 at some stage. This will leave many wondering whether the US dollar weakness we saw yesterday will be a prolonged move. The simple answer lies in the data and if we can see US data track above expectations, then the greenback is likely to adjust accordingly. On the euro side of the equation nothing has really changed for now and once the short covering gets out of the way, traders will be looking to reassess their position on the pair.