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They effectively make the FOMC meeting about as dovish as the various playbooks had suggested it would be. The destruction of short-term US bond yields were testament to this view, although some of the commentary from Janet Yellen around the domestic economy was actually fairly upbeat.
It seems logical the central bank would have raised rates if it weren’t for recent international developments, but they tried desperately to buy themselves flexibility. This was shown in the narrative where they detailed they are ‘monitoring developments abroad’. This will not surprise too many given the prompting from economists such as Krugman and Stiglitz, and organisations like the World Bank and IMF. With this in mind, Janet Yellen has also detailed that it might take some time to evaluate the impact of recent global developments.
So when will rates rise?
Looking forward, the October meeting is a ‘live’ one, but the current 19% implied probability of a hike occurring seems fair and they will need to call a press conference if they are serious about raising rates. I’m sure the mere mention of a press conference will get traders excited and cause probability to spike.
The base case then remains a hike in the December meeting, with the concern here being this would be significantly bearish as it would lead to a credibility issue if we get another bout of emerging market lead volatility and the Fed push back again.
Once again, and in-line with its 20-year policy of hiking when the market has priced an above 50% probability or more, the Fed have shown they are very cognisant of market pricing. Of course, when they show such little confidence in their inflation outlook, they are going to hold off from tightening policy amid rising concerns around external demand and fragility in other economies.
But market participants will therefore continue monitoring the implied probability of a December hike and, worryingly, the fed funds future is pricing a mere 45% chance of a December hike. That shouldn’t fill anyone with confidence they will hike this year, but it does give them flexibility. In this vein, it is perfectly clear that it should be seen as positive for the USD and developed-market equities if the Fed looks to raise rates.
Effect on other central banks
It also begs the question: How should the European Central Bank (ECB) and Bank of Japan (BoJ) respond to the Fed’s dovish turn? It certainly increases the probability we’ll see the BOJ increase the run-rate to its current QE program at its 30 October meeting, and Japan’s economic minister Amari has given his stamp of approval to Fed inaction in commentary today. It will add fuel to the calls for the ECB to also add to its QE program this year, especially with EUR/USD trying to find stability in Asia above the $1.1400 level.
The Reserve Bank of Australia governor Glenn Stevens has spoken today and provided no indications that the failure of the Fed to hike would push the Aussie central bank to further ease policy. He even spoke about current levels of the AUD sitting nicely aligned to their models. This has provided some support to the AUD after being the victim of the Fed’s negative undertones around China. The market is pricing a 43% chance of a cut from the Reserve Bank this year, but Mr Stevens just isn’t making the right noises to justify this probability. AUD/NZD longs look compelling on this ground.
The markets’ response
Despite the fairly downbeat Fed, Asian markets have been generally bid and it’s interesting to see a strong 1.7% reversal from the opening low of 5093 on the ASX 200. Volumes have been terrible though, so it’s not been hard for the market to move around.
As in the US, the really aggressive buying has taken place in Australian bond markets (the Aussie 3-year treasury is 8bp lower at 1.93%). China has pushed a touch higher on further signs of stabilisation in its property market, but as always it’s all about the final hour when the shenanigans kick in.
Japan is laggard with the Nikkei losing over 1%. A weaker USD/JPY is at the heart of the equity move and one just has to pull up a daily chart to see the market has no idea where this pair is going. Consolidation is the name of the game and, as always, it’s best to let the market push you into a trade and let it be the guide rather than second guess when you these factors in play. I’d look to buy or sell the break.
So what have we learnt from this hugely scrutinised event? Firstly, the Fed is genuinely concerned about the external picture. We know that markets are largely leading the way and will dictate market pricing around future meetings, which in turn will lead the Fed. Plus, we know there is even less clarity now than yesterday on the macroeconomic landscape. It’s for perhaps this reason that the speculative funds have amassed the largest net short position on S&P futures since January 2012 (-227,000 contracts).
It promises to be a very interesting session in Europe and the US, as traders have time to really assess the Fed’s view and what it means for markets. As always, the first move might not be the right move and cooler heads should prevail.