The day the hawks died

Markets participants broadly expected the FOMC to be quite dovish. They were right. Back in December last year, it was considered reasonable to expect at least one rate hike in 2019. In January and February, multiple speeches from Fed members suggested that it was still a live possibility but that it would depend on developments on the economic side. Yesterday, Federal Reserve Chairman Powell put a final nail in the coffin of a rate hike this year, saying that interest rate could be on hold for “some time”. Looking at the dot-plots, Fed members are expecting one rate hike next year, at the earliest. They also slashed growth forecast for the next two years. The economy should grow 2.1%y/y in 2019 compared to 2.3% estimated in December. For 2020, the initial forecast of 2% has been trimmed to 1.9%. Inflation forecast have also been revised to the downside: 1.8% in 2019 (1.8% in December) and 2% in 2020 (2.1% in December). However, core inflation forecast have been left unchanged at 2% for both 2019 and 2020.

Officials also decided to put an end to their balance sheet reduction program by the end of the third quarter 2019. The reduction is going to start slowly in May. Only a few months ago, the Fed was anticipating that the balance sheet would have to reach around $2tn and $3tn before putting the process on hold, nowadays it looks like $3.7tn is good enough…

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The main question is whether the market will focus on the fact that the Fed has put on hold quantitative tightening, which means that we are back to the situation where bad news is good news since it means free money, or the fact that the growth outlook has been slashed, which means that a recession may be around the corner.

In the equity market, most indices reacted negatively in the end, even though investors initially loaded on risk after the announcement (old habits). Today, it like investors do not know where to stand: S&P 500 future are down 0.10%, the German DAX is down 0.30%, while the SMI slid 0.35%. The yellow metal is up 0.42%. Interest rates are down across the board. The greenback took a massive hit as it lost ground against all of its G10 peers, with the exception of the pound sterling, thanks to Brexit uncertainties. We maintain our bearish view on the buck and anticipate that investors would become increasingly cautious against such a negative backdrop.