US stocks were weaker Wednesday, the S&P closing 0.5% lower. Equities had moved higher immediately after the Fed announced it expected to keep policy on hold until it achieves "maximum employment" – at least through 2023. But that bounce didn’t even survive Chair Powell's press conference, which provided the actual litmus test. One element missing overnight, which might have served as a dovish surprise if delivered, was weighted average maturity extension. And with no reference to that in the post-meeting statement – and essentially radio silence from Powell in the press conference – it provided the markets with a less dovish view.
Many tech stocks look attractive after last week’s sell-off but are not yet sponsored by flows and investors are not taking the previous week's gnarly warning shot on tech sector ownership concentration lightly. With the market’s less dovish take on the Fed, combined with Chair Powell's clouded economic viewfinder as seen through Congress's nonreactive fiscal lens, it certainly proved to demoralize investors. There simply wasn’t enough dovish medicine in the FOMC cure-all policy to sweep away the September blues, fiscal impasse, and all.
FOMC still delivered what they could
Still, the Federal Reserve provided as strong a guidance on rates as it possibly could.
Fed funds will stay at zero until inflation has realized 2% and is also forecast to moderately overshoot to meet an average inflation target. It also said that it would need to see maximum employment (it did not express what that was, but it considers the long-run natural rate at 4.1%). As Chair Powell put it during the press conference, "Effectively we are saying that rates will remain highly accommodative until the economy is far along in its recovery."
Shores up the market backbone
This should unquestionably shore up the market backbone as it continues to claw back losses from last week's tech sector rout. After all, Powell was as dovish as he can be rhetorically, which should be enough to keep markets stable. And we should expect the wall of money and "four bastions of tech to re-engage" – computerization, digital transformation, workflow automation and e-commerce simplification. After all, the mega-cap tech stocks have good reason to cope with the virus well, if not take outright advantage due to lengthy stay at home mandates from employers.
Traders did not blink
Traders did not blink – mainly because the commitment had been so clearly telegraphed by Fed Chair Powell's speech at Jackson Hole and the associated publication of the Fed's new statement of goals. However, that should not detract from how remarkable the Fed's language is. Unless there’s a significant breakdown in financial stability, the Fed is making a monetary commitment as strong as the BoJ's: rates will not rise until the goal has been met.
The Fed's novel twist on inflation-targeting did not provide the nail in the dollar's coffin, and with more head fakes than breaks, the current ranges may be set in stone for a bit.
For currency markets, it’s tough to say how the FOMC decision fares relative to expectations, simply because there didn’t seem to be much of a consensus. Yet there wasn’t much in expectations around the QE twist, so no real disappointment there. The language around maintaining the target until inflation rises to 2% delivers the Fed's forward guidance on the inflation aspect. Still, for all the talk about letting inflation overshoot, I think the language is weak on this front, so EURUSD slid on the day.
In a market that’s grown weary of selling USD in the past couple of days leading up to the FOMC, albeit mainly vs. JPY and gold, we could see more room for the US dollar to correct higher.
And with EURUSD running out of steam again at 1.1900, there will be more disappointment this time around, suggesting a more lasting fade of the recent spat of USD weakness. Indeed, along with increasing new Covid-19 cases in Europe and new regional lockdowns and ECB comments on the currency, it could eventually bring bullish EUR positions to a halt and even reverse in the short term.
People didn’t expect much from the Fed, but they’re short USD anyway, either for reasons unrelated to FOMC (JPY) or because short USD is the asymmetry/lotto ticket trade through yesterday's meeting.
If you want to fade the crowd, EURUSD is the best straight-up vanilla expression to trade the long dollar. There are many EURUSD longs out there despite the recent wave of profit-taking when 1.1900-30 was rejected after Lagarde and Philip Lane spoke at the ECB meeting so that traders will have a precise stop loss level near there.
Japanese PM Abe's decision to stand down represents the end of an era. Using flow dynamics and accounting for real rate differentials, the yen screams as much as 15-20%% too cheap. The new PM will face a more challenging environment where all the easy policy options have been tried, his authority is more limited and, for the first time in a decade, JPY outflows are reversing as FDI outflows drop sharply in a lagged response to corporate profits plummeting and supply chains being internalized. The long JPY trade has little to do with Fed policy but as much to do with the shifting tides of real money flows.
For gold, things haven’t changed. For all the noise around AIT, the market remains more assured about the FOMC ability to anchor rates lower for longer than they do about central bank policy to trigger inflation. With no QE twist on offer, gold traders barely blinked as it’s back to the waiting game for inflation breakevens to nudge higher.
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