What was one "one and done", just became "none and done" as the Fed will no longer hike in 2015 and will certainly think twice before hiking ahead of the presidential election in 2016. By then the inventory liquidation-driven recession will be upon the US and the Fed will be looking at either NIRP or QE4. Worse, the Fed just admitted it is as, if not more concerned, with the market than with the economy. Worst, suddenly the market no longer wants a... dovish Fed?
* * *
While consensus was split if the Fed was going to hike or keep rates the same (although with Goldman pushing for the latter and even urging further easing, it is no surprise for the first time ever a FOMC member suggested negative rate), everyone was expecting some hawkish component to yesterday's FOMC announcement: either the hike itself, or a hawkish "hold" in which the Fed would promise a hike is imminent any moment. After all, 7 years later, the market needed at least a little confirmation that the economy is finally starting to pick up through the lens of the Fed. Nobody expected that dovish mess that was unleashed at 2pm yesterday, in which the Fed explicitly made it clear that it now has a third mandate: responding to Chinese and global events, and that a rate hike is virtually impossible any time emerging markets are "tantruming" due to the same dollar strength that accompanies any pre-hiking intentions, thus proving what we have said all along: the Fed is trapped in a catch 22.
This is how JPM's chief economist Michael Feroli summarized the confusion unleashed by the Fed:
"While that outcome wasn’t too much of a surprise - we were leaning toward a hike but thought it was basically a coin flip - what was a surprise was the dovish statement and dovish tone of Yellen’s remarks in her post-meeting press conference. Rather than reinforce the message that a rate hike before year-end is highly likely, she gave little sense of growing confidence that inflation will return to its 2% objective over time."
As for the Fed admitting it is now trapped by the market, here is Vanguard's senior economist Roger Aliaga-Diaz:
"We are concerned with the Fed's acknowledgement of recent market volatility in its decision. The Fed runs the risk of being held captive to the markets as, paradoxically, much of that volatility is due to the anticipation and uncertainty around when the Fed will move."
What's worse, said Catch 22 also confirms that just like all other central banks who hiked just to ease promptly thereafter, starting with Japan's failed attempt to escape ZIRP in 2000 [30] and continuing through all the aborted rate hikes in the New Normal [31], a reflexive attempt to stimulate confidence, and thus inflation, by hiking rates first and hoping inflation follows, will not work forcing central banks to consider the "last option" (hyper)inflationary paradigm - direct monetary injections to the general population bypassing the bank transmission mechanism, where money creation is trapped in capital markets. In other words, monetary paradrops. That, of course, would be the final event before central banks lose all confidence, and incidentally is precisely why the market is trading as it is right now: down big in response to the most dovish Fed we have seen in over two years.
In the meanwhile, the market itself is stunned with its response to the Fed decision: while dovish holds such as this one has previously been almost inevitably bullish for risk assets, the selloff following 2pm's kneejerk response and the ongoing selling overnight, confirms something is very wrong not only with the global economy, but the market's "reaction function" to the Fed's "reaction function." Just as bad, the debate remains: when will the Fed hike, bringing with it the attendant volatility; and if the Fed does not hike, will it at least go NIRP or launch QE?
For now, all these are seen as dollar negative which is bad news for the 'recovery' narrative but good news for emerging markets for the time being.
As a result, while Emerging Markets are enjoying a brief but acute rally on the heels of dollar weakness overnight, developed market stocks are currently tumbling in virtually every market, from Japan which was down 2%, to Europe, to US equity futures which were up early but have since followed the USDJPY far lower as markets are now "tantruming" and demanding that if the Fed will not hike rates, then at least the BOJ or ECB will provide more QE.
The somewhat bright spot was Asian development markets where equities traded mostly higher as the region digested the Fed's decision to keep rates unchanged but reiterated that a 2015 rate lift-off remained on the table. ASX 200 (+0.5%) and Shanghai. Comp. (+0.4%) traded in positive territory following the FOMC decision, while an improvement in Chinese new home prices (Y/Y -2.3% vs. Prey. -3.7%) further supported sentiment. Nikkei 225 (-2.0%) underperformed ahead of its extended 5-day closure with the index weighed on by a stronger JPY. JGBs tracked the firm gains seen in USTs as domestic pension funds were said to be in bids for bonds in the super long end, while the BoJ also entered the market to purchase JPY 820b1n in government debt.
Cautious sentiment dominated the price action in early trade, as market participants re-position following the decision by the Fed to leave rates unchanged . At the same time, Fed's Yellen put particular emphasis on China and the recent market volatility in her press conference. As a result of the cautious tone European equities opened in the red (Euro Stoxx: -1.8%), with defensive sectors outperforming. Despite coming off the best levels of the session, both Bunds and Gilts are trading sharply higher, with Euribor and Short-Sterling curves flattening as market participants re-price rate hike expectations.
In FX, it has been a dollarpocalypse the hours following the FOMC announcement with the EUR gaining across the board, as the currency is now viewed as a slightly less attractive option for carry related trades and as such some unwinding has been observed. On that note, analysts at Bank of America have increased their EUR/USD forecast to 1.05 by the end of the year. The USD has continued to soften overnight (USD-Index: -0.5%) to see strength in major pairs, while safe haven flows to JPY have seen USD/JPY fall over a point to below the 119.50 level. At the same time, high-yielding currencies have been the main beneficiary with CAD and AUD seeing strength overnight despite the bleak outlook for metals and energy markets.
The commodity complex has seen further strength on the back of the week USD overnight with gold higher by over USD20.00 since the release of the FOMC rate decision. Elsewhere, copper and iron ore prices were mildly pressured with the latter on course for its worst week in over 2 months as a lack of demand from the world's largest consumer China continues to weigh. WTI and Brent futures both reside near intraday highs heading into the North American crossover and on course to finish the week in positive territory.
There is nothing on the US calendar today, which gives markets even more time to digest the confusion the Fed unleashed yesterday.
Bulletin Headline Summary
- Cautious sentiment dominated the price action in early trade, and as such European equities opened in the red with defensive sectors outperforming
- EUR gained across the board, as the currency is now viewed as a slightly less attractive option for carry related trades and as such some unwinding has been observed
- Looking ahead, notable events on the calendar include Canadian CPI as well as comments from BoE's Haldane and ECB's Coeure
- Treasuries extend post-Fed rally, move to gain on week after Yellen cited concern over slowing growth in China and turbulence in global markets for keeping rates unchanged.
- Fresh charges in the U.K. Libor rigging investigation may target traders linked to the benchmark’s euro counterpart, with prosecutors focusing efforts on that strand of the probe in recent weeks
- Greece’s election remains too close to call as a three-week campaign wraps up on Friday with no clear front-runner in a vote that may put Europe’s most indebted state on course for thorny coalition talks as of next week
- China’s stocks capped their steepest weekly loss this month as turnover shrank amid growing concern government measures to support the world’s second-largest equity market and economy are failing
- Life is getting better in the U.S. even with stagnating wages for some workers, thanks to improvements in technology and cars, according to JPM’s Jamie Dimon
- Abe’s fiscal policy is backfiring again: More than a year after a sales-tax increase tipped Japan into a recession, efforts to clamp down on soaring pension payments are suppressing a recovery in consumer spending
- PBOC orders banks to tighten supervision of their clients’ FX deals, Reuters reports, citing unidentified people with direct knowledge of the matter
- Sovereign 10Y bond yields lower. Asian stocks higher with the exception of Japan. European stocks, U.S. equity-index futures decline. Crude oil, gold and copper rise
US Event Summary
- 10:00am: Leading Index, Aug., est. 0.2% (prior -0.2%)
- 11:30am: U.S. to sell $13b 10Y TIPS
DB concludes the overnight wrap
So the Fed stands pat and the spell of record low rates continues as concerns about developments abroad and the fragility of markets proved to be enough of a red flag for policymakers. The overall tone and message from both the statement and Fed Chair Yellen certainly felt like it was weighed more towards the dovish end of the scale. Median dot plot estimates were lowered by a quarter basis point for the next three years (leaving one hike for 2015), while the LT rate was also notched down by the same proportion to 3.5%. Growth and inflation expectations for 2016 and 2017 were revised down, while the 2% core inflation target was moved back to 2018. The stronger Dollar and the disinflationary impact that this is having was an overriding theme. There was some support from Yellen on the improvements in domestic activity with both business spending and the labour market in particular highlighted. She also kept the door open for a move this year, including October, but once again the timing was downplayed with the expected path of rate rises re-emphasized as the more important factor.
In terms of the market reaction, the price action in Treasuries actually started about 45 minutes pre-FOMC as yields moved south in a hurry. The most notable move was in the 2y which was already down about 5bps prior to the release. The yield then plummeted a further 8bps post-decision and Yellen conference, finishing the day 13.1bps lower at 0.682% and in turn marking the biggest single day move lower since March 2009 when the Fed announced its QE program. The 10y closed just over 10bps lower at 2.191%, although it’s worth noting that it’s pretty much back to where it was at last Friday’s close. Meanwhile, the Dollar unsurprisingly came under decent pressure, the Dollar index finishing down 0.91%. Some of the more interesting price action came in risk assets. Equities initially rallied on the decision, the S&P 500 jumping as high as +1.3% before nerves crept in as Yellen’s press conference got underway, with the index eventually paring all of that move and more, closing down -0.26%. Credit indices saw a similar trend, CDX IG finishing about half a basis point tighter after trading nearly 3bps tighter.
While there weren’t huge changes to the statement put out by the committee, the main focus was on the paragraph ‘recent global economic and financial developments may restrain economic activity somewhat and are likely to put downward pressure on inflation in the near term’. This was followed up by Yellen in her press conference saying that officials had decided to stay put ‘in light of the heightened uncertainties abroad’. Yellen balanced this with supportive comments around the state of the domestic economy, but that was already overshadowed somewhat by a cut in growth estimates by the committee for 2016 (to 2.3% from 2.5% previously) and 2017 (2.2% from 2.3%), while core PCE projections were notched down to 1.7% (from 1.8%) and 1.9% (from 2.0%) respectively. The proportion of Fed officials now expecting a move by the year end has dropped to 13 out of the 17 officials, down from 15 who expected such at June. As mentioned median dot plots were nudged down 25bps and one committee member is now advocating for a rate cut.
As DB’s Peter Hooper notes, the Fed has now added considerable complexity to the task of divining when conditions will be ‘right’ in their view by stressing the importance of economic and financial market developments abroad as well as at home. The door has been kept open for now, but one has to think that that door is slowly starting to creak shut and a lot will rest on how markets react over the next month or so. As we stand, market pricing for an October hike is at just 18%, while December is currently at 44%.
In terms of trading in Asia this morning, with the exception of Japan - which has been weighed down by a stronger Yen - most major equity bourses have followed up in a positive manner, although not without some early swings. In China the Shanghai Comp and CSI 300 are up +0.40% and +0.62% respectively at the midday break, although the former has crossed between gains and losses eight times already. Elsewhere the Hang Seng (+0.42%), Kospi (+0.63%) and ASX (+0.88%) have all taken a leg up, although in Japan we’ve seen both the Nikkei (-1.39%) and Topix (-1.62%) tumble. Oil markets are more or less unchanged after falling over a percent yesterday, while Gold (-0.30%) has given back some of yesterday’s post FOMC gains. S&P 500 futures are currently up +0.2%, while Treasuries have seen little change. EM currencies have firmed although no more than three-tenths of a percent while Asia credit is generally a couple basis points tighter. Meanwhile, August home price data out of China this morning was reasonably supportive with prices rising in 35 of the 70 cities from the previous month.
Unsurprisingly there wasn’t much to report in the European session prior to the Fed yesterday. Equity markets were fairly mixed. The Stoxx 600 closed -0.18% while there were some modest gains for the DAX (+0.02%) and CAC (+0.20%) although in fairness there was little conviction for most of the session. It was a decent day for European credit though. Crossover closed some 7bps tighter and Main finished 1.5bps tighter.
Despite the obvious main event of the Fed taking up most of the attention there was also some data out yesterday. The highlight was a soft headline Philly Fed business outlook print for September which declined over 14pts to -6.0 (vs. +5.9 expected). The reading was the lowest since February 2013, although there were some positives in the details. Notable was a decent leg higher for capex expectations, while there were also firmer new orders and employment indices numbers. The six-month ahead outlook also rose relative to last month. Elsewhere, both housing starts (-3.0% mom vs. -3.8% expected) and building permits (+3.5% mom vs. +2.5% expected) readings recorded beats. Finally initial jobless claims declined 11k last month to 264k after expectations of no change. Meanwhile, in the UK we got an in-line +0.2% mom gain for retail sales for August, with the ex auto and fuel reading also printed as expected at +0.1% mom.
Before we get onto the day ahead, one event which has somewhat flown under the radar is Greece’s general election this Sunday. The recent polls have been too close to call, with fairly evenly split support for Syriza and New Democracy although neither is likely to control a majority in parliament. The successful conclusion of the 3rd ESM package and broad-based political support to meet creditors’ demands eliminated a lot of the political risk however and as DB’s George Saravelos pointed out previously the eventual outcome of the vote may not entail particularly different paths ahead. The bigger picture is the popular support towards underlying Eurozone membership as the key underlying factor behind ensuring that Greece’s path towards stabilization is in place.
It’s a quiet day for data today, with the focus set to be more on the price action following the Fed. There’s nothing of note in Europe this morning, while over in the US we’ve got the Conference Board’s leading indicator as the only notable release. Tomorrow we get the first Fedspeak post yesterday’s decision with Williams and Bullard both due to speak on the US economic outlook, so it’ll be worth keeping an eye on that.
