In a clear case of ‘sell the rumour, buy the fact’, the FOMC raised the Fed's funds rate target by 25 bps last night sparking a rally across the US Treasury (UST), stock, emerging market forex, Latam, Middle East and Far East bond markets.
The rate hike was followed by a much more dovish Fed statement than was previously expected. In the post announcement press conference Fed Chair Janet Yellen stated, ’It is likely that target policy rates will go up in line with their forecast. As such we don’t expect any acceleration in the pace of hikes as long as economic developments remain on track, as a result, we maintain our monetary policy outlook, expecting two more hikes this year and two more next year’.
Of course the market remains sanguine regarding these further rate hikes, and continues, as it has over the last two years, to have lower rates priced in. If we look at the medium of the Fed's ‘dot plot’ path they have indicated Fed funds rates at 2.25% by year-end and 3% at the end of 2018, much higher than the OIS (Overnight Indexed Swap) priced by the market; which implies around 1.35% at the end of this year and just 1.75% at the end of 2018. Strikes us that if the Fed does enact two more hikes this year, consistent with their current path of just 25bp per move, that puts the higher band of the Funds rate at 1.5% not 2.25% as inferred by the ‘dot plot’ medium path and so this indicator looks to be an inaccurate measure given Yellen’s statement.
As mentioned above, UST rallied across the curve sparking a global bond rally with 5-year yields 13bps lower than this time yesterday, now at 2%, and 10-years 11bps lower, now trading around 2.5%. Basically, we have been saying the market was oversold coming into the meeting as 10-year UST yields had moved up around 20 basis points since February month-end and at this morning’s levels we now make UST rates at fair value given the economic and political outlook for the up-and-coming Trump budget etc. Broadly, we feel there is a risk premium already built into current pricing although we still see the longer-end of the yield curve as the best value, and with the highest potential return on a risk adjusted basis.