Key news
Twist but no shout – Fed delivers slightly less than markets had expected.
Operation Twist has been extended to year-end but the bar is low for further easing.
Stocks closed with only minor losses in the US, Asia mainly lower.
Spanish bond spreads narrowed significantly, focus on today‟s auction.
Chinese manufacturing PMI falls to 48.1.
Markets Overnight
Fed delivered slightly below market expectations as Operation Twist (where the Fed sells short-term securities and uses the proceeds to buy longer-term securities) was extended to year-end but mortgage-backed securities were still not included. Further, there were no changes in the guidance on rates and the Fed still expects to keep rates exceptionally low „at least through late 2014‟.
Some of the initial disappointment was, however, countered by a softer tone on the economic outlook and a clearer easing bias. At the press conference, Ben Bernanke highlighted that further easing would certainly be considered if “we don‟t see continued improvement on the labour market”.
US stocks dropped about 0.5% on the Fed announcement but sentiment quickly recovered and the key indices closed with only minor losses. The reaction on the bond market was fairly limited with the longer end gaining though. EUR/USD traded with some volatility and printed a 1.2743 intraday high before falling back to around 1.2670.
With unemployment above 8% and core inflation around 2% y/y the Fed should be in a position to ease monetary policy. The steps taken yesterday are not sufficient to have a real economic impact as the balance sheet is not expanded and hence no new money provided. However, there is clearly not yet a majority within the FOMC to address the weaker US growth outlook and it will likely take a couple of more months more with weak labour market data for the Fed to react (see Flash Comment US: Fed doing twist but no shout, 20 June 2012, for further details).
It is negative for risk assets that the global growth slowdown has so far only triggered modest monetary easing – with China and Australia among the few to act. However, it is positive that a majority in favour of additional stimulus is close to being formed in most of the key central banks. As argued above, the bar should be low for QE at the Fed; BoE minutes yesterday showed that Governor King lost a vote just 5-4 for more QE; and there were members at the ECB calling for a rate cut already at the last meeting.
European peripheral bonds performed strongly yesterday - with the 10-year Spanish yield falling 30bp to below 6.70% - potentially on speculation that Italy, France and Spain will try and push for Europe‟s rescue funds to start purchasing bonds.
