Today the US dollar seems to have halted the decline it had endured for the past few days. Treasury yields struggled to find their equilibrium yesterday, ending the day mostly flat, and are a touch lower today ahead of the forthcoming Fed meeting minutes. We should be able to see a little more detail on the discussions around unwinding the balance sheet and perhaps some important insights into the Fed’s view on the recent low core inflation figures. In any case, enjoy the finer points from what could be Yellen’s penultimate “full” Fed meeting (November and January meetings omit Economic Projections and Chair press conference).
Today the dollar continued its rally along with US equity indices whilst 10-year Treasury yields rose 5 basis points. The DXY Index is now up more than 1.4% so far this week; at 93.4 at time of writing, it is now back to where it was this time last month. Some of this may be due to profit taking from the recent rally in the euro (which is still up around 12% versus the US dollar year to date). The rest of the dollar rally and sell-off in Treasuries stems from hawkish comments from Fed Chair Yellen (and New York Fed President William Dudley) as well as market optimism over the anticipated tax proposal from President Trump later today.
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.
Yesterday’s hawkish testimony from Fed Chair Janet Yellen sent the Dow and SP500 to new all-time-highs along with a rally in the dollar and global equity markets and pushed Treasury yields back above 2.5%. Markets seem to have focused on her reference to the recent improving economic data - drawing a consensus that a June (or even the possibility of March) rate rise may be on the table. However Yellen also stressed caution over the uncertain economic picture; notably the risks and ‘considerable uncertainty’ associated with the current administration’s plan to boost growth through further unsustainable fiscal stimulus. In contrast she stressed ‘the importance of improving the pace of longer-run economic growth’.
We have long spoken of our thoughts on negative interest rate policy (NIRP), quite frankly we do not believe it is an effective strategy to avoid the deflationary spiral, or spur growth. Unfortunately for the likes of the BoJ and eurozone, there was very little ammunition left on the table to deploy. In Denmark, where negative rates were adopted almost four years ago, studies show that NIRP is counter-productive as the private sector for example is actually saving more than when rates were positive!
After a couple weeks of hawkish comments from Fed members, Fed Chair Yellen stepped out for the first time since the last FOMC meeting mid-month and remained true to herself; maintaining her dovish credentials. A cautious approach in adjusting policy was the theme of her speech which she delivered at the Economic Club of New York yesterday. She highlighted that a cautious stance is “warranted because, with the federal funds rate so low, the FOMC's ability to use conventional monetary policy to respond to economic disturbances is asymmetric”. Like us, she noted that domestic inflation is “somewhat more uncertain” adding that although there have been signs of pick-up, US economic indicators remain “somewhat mixed”. With increasing global uncertainty, Yellen even discussed the central bank’s “considerable scope” to ease if the economy falters, “we used them effectively to strengthen the recovery from the Great Recession” and would do so again, adding that “only a modest degree of additional stimulus” can be provided.
Happy St. Patrick’s Day! Once considered a strictly religious holiday in Ireland, with pubs closed nationwide, in 1970 the law was overturned and the stout was poured with pride!
As we had expected, the FOMC did not move to raise rates yesterday, and in fact surprised the market with its more dovish than expected stance; revising the dot plots down to two (and a quarter) rate hikes this year from four back in December, the median dot is now at 0.875%. The benchmark 10-yr UST climbed to 1.997% ahead of the meeting, falling ~10bps by the end of the session. On balance the US economy has shown signs of stability and in some sectors, i.e. the job market, further strength. What continues to remain of concern to the central bank members is the spillover from “global economic and financial developments” which have recovered somewhat off the lows seen earlier this year.
Assessing the economic impact for a leap year is a question that still seems to be unanswered. In the UK the National Statistics Office adjusts GDP so that February is considered 28 and a quarter days long every year therefore avoiding any problems. In the States there is another problem with the leap year, the presidential election, with halls filled with voters and billions of dollars spent on getting to the winning line the Federal Reserve has to think carefully of any disturbances due to the various campaigns.
With China still out celebrating the new year, other Asian markets have reopened to a massive hangover. 2016 is the Year of the Red Monkey, we hope that is not a reflection of the markets going forward, although it has been a colour the equity markets have gotten used to in a flight-to-safety February. The red signifies fire, which in turn assumes spark and brilliance, while the monkey is clever and energetic; let’s hope this cheeky monkey does indeed bring some much needed brilliance to markets this year.
So, the Fed’s influential trio came out to play yesterday; all suggesting that a US rate hike in December remains firmly on the table; but the decision remains very data dependant. At yesterday's testimony before the House financial services committee, Fed chair Janet Yellen stated that current domestic economic conditions are “pretty strong and growing at a solid pace” though the spillover from the global economy has been somewhat of a drag. She went on to say that the committee has been expecting the US economy to “continue to grow at a pace that is sufficient to generate further improvements in the labor market and to return inflation to our 2% target over the medium term”, adding that “if the incoming information supports that expectation then our statement indicates that December would be a live possibility.” Markets were quick to react to Yellen’s hawkish comments, with futures hiking up the probability of a rate hike at the final meeting this year to 58%; from 50% before the statement, and just 33% last month. Treasury yields spiked higher, with the two-year yield racing to its highest level since early 2011.