Dollar steady and equities struggle in wake of FOMC
There was little change in the overall Fed outlook last night, but there was still plenty to digest for the dollar and equities.
The Fed will leave rates unchanged for the foreseeable future. We knew this anyway, but to have it confirmed is still important. Their commitment has been reinforced by their focus on the downside risks to the economy, giving much less weight to any stronger-than-expected economic recovery. However, there is no commitment to increase either the level or pace of asset purchases. This perhaps explains much of the market reaction, with equities struggling and the dollar finding its footing to a degree.
While policy stays as it was, the economic outlook has been upgraded. The recession is not expected to be as severe as feared and employment is forecast to be stronger than previously thought. But the Fed continues to focus on the worse-case scenarios, assuming a long and slow recovery, like 2009. But this isn’t 2009. As Tim Duy of Oregon University notes, there was nothing wrong with the economy in January, and at the present time household finances have strengthened and the economy is growing.
The Fed’s desire appears to be to let the US economy rebound, and in strong fashion, rather than attempting to rein it in. As a result, the outlook for risk assets is strong, since real rates are effectively around -2%. The statement last night outlined in definite terms that it would leave rates at near-zero until a) the US economy is at maximum employment and b) inflation is at 2%. Given that b) has been hard (though not impossible) to achieve, it would not be surprising to see rates stay low well beyond 2023.
The bar for a rate hike has been set very high indeed. But a reduction in asset purchases is a much more likely scenario if 2021 shows stronger than expected growth.
Market impact
Dollar: The dollar rallied into the decision and beyond, due to the lack of any substantial commitment to change policy. But the overall outlook is still very accommodative, which means the greenback may struggle to make much headway. 92.80 has been a very solid floor for the dollar basket so far this month, so don’t expect it to go without a fight. In a similar vein, short-term upside has been capped at 93.60. As the dust settles, traders may want to wait for signs of a clear direction emerging in the near term.
Stocks equities faltered in the wake of the statement; how far this is the beginning of normal late September/pre-election weakness is yet to be seen, but indices have yet to breach the lows from earlier in the month. It is true that the statement contained little to excite equity bulls, but with breadth picking up again this might still be a bear trap. A push below 3300 would be the necessary prerequisite to take a more negative view.
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