Markets Today: Cautious Fed

As expected by most, US Fed Officials left the Fed funds rate unchanged at 0.25% – 0.5%.

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As expected by most, US Fed Officials left the Fed funds rate unchanged at 0.25%- 0.5% and lower their projections of futures rate hikes (Kansas City Fed President Esther George was the only dissenter). The median of policy maker’s projections now sees the funds rate at 0.875% at the end of 2016, implying two 25bps hikes in 2016 compared to four hikes in December. Rate hike projections were also lowered in the outer years. By the end of 2017, the funds rate is now seen at 1.875% vs. 2.375% previously and median forecast for the end of 2018 is now at 3.0% compared to 3.25% in December. The longer run projection was also lowered to 3.25% from 3.5%. The lower rate forecast projections are predicated on the view that growth will remain sluggish. Now growth for 2016 is seen at 2.2% down from 2.4% in December. For this year, unemployment is expected to fall only marginally to 4.7% and somewhat surprisingly PCE inflation is expected to decline to 1.6% compared to its current level of 1.7%.

The statement also gave a sense of a more dovish tone. Previous comments in relation to balance of risks to the outlook were dropped and instead a new sentence was added noting that “global economic and financial developments continue to pose risks”.

Ahead of the FOMC announcement and in a light trading environment, the USD was well bid while equity markets and core global bond yield traded mostly sideways. Pre-FOMC the DXY index was up 0.25%, with the USD strong against almost all the major currencies. The CAD was the one exception, aided by a rally in oil prices.

Post the announcement reaction to a more dovish Fed has boosted risk assets and this has also been aided by press conference comments from Fed Chair Yellen emphasising the fact that” Caution is appropriate”. US Equity indices are closed between 0.4%-  0.8% and the USD dollar is weaker across the board. Commodity related currencies are the outperformers with NZD sitting at the top of the leader board, up 2.03% over the past 24 hrs. The AUD has gained 1.27% and is back above 75cents.

US Treasury yields have also reacted positively, 10y UST yields rallied nearly 8bps immediately after the announcement and now they are currently trading at 1.92%, about 0.5bps higher.

A more dovish Fed is no doubt risk positive, but as we learned earlier in the overnight session, US core CPI rose to 2.3% from 2.2%yoy, reaching its highest level since May 2012. The new projections show the Fed expects a gradual path to 2% in core PCE inflation by the end of 2018. However, if the recent upward trend in core inflation is any guide, that 2% target will be reach a lot sooner than expected.

In other news/data releases, US Housing starts came in better than expected (Jan 1178k vs 1150k exp, whilst Industrial production fell lower than forecast (Feb -0.5 vs -0.3 exp). The UK Budget showed downgraded economic forecasts and weaker fiscal metrics.  Both tax cuts spending cuts were pledged amidst a promise to return to budget surplus by 2019/2020.

Coming Up

In Australia this morning and ahead of the labour force report (11.30 AEDT) we have RBA Debelle speaking in Sydney.But given that his speech is on regulatory issues, we would suggest that his comments are unlikely to be market moving.

As for the Labour force report, our economists have noted that the RBA seems more prepared to ease monetary policy if the improvement in Australian employment does not continue (or if financial market turbulence leads to slower global or local demand).

For this month, the market consensus is for the unemployment rate to be unchanged at 6.0% and for employment growth to be +13.5k. NAB expects the unemployment rate to fall to 5.9% and for employment to print stronger at +18k.

The market is currently pricing around 21bps of RBA rate cuts over the coming year and when considering the global and local risks, pricing is probably more vulnerable to a weaker than expected employment print rather than a strong one. For the AUD, we would note that the unemployment rate should have the more enduring impact relative to the change in employment, even if the latter continues to draw the initial (knee-jerk) response – a result of ‘algorithmic traders’ programming to react to any significant surprise on headline employment.

Looking at offshore markets, this morning Japan releases its trade data for February. On a seasonally-adjusted basis, the trade surplus is expected to improve to ¥235bn from ¥119.4 bn. Later in Europe, we also get the Eurozone trade balance along with the final CPI reading for February. Across the Channel, the BoE makes its policy rate announcement and while no change is expected, the committee’s views on the outlook will be closely monitored, particularly given the fiscal tightening heralded by the Chancellor overnight.

The US has a busy calendar with the Philly fed survey, current account(Q4), initial jobless claims , Jolts job openings (Jan) and leading index (Feb) all due for release. Following the better than expected Empire State survey released earlier in the week, the market will probably look at the Philly Fed survey for confirmation of this improvement in the manufacturing sector. Given the strong jobless claims print last week (259k), a partial payback is expected with the consensus anticipating a reading of 268k for this week.

Overnight

On global stock markets, the S&P 500 was +0.60%. Bond markets saw US 10-years -5.30bp to 1.92%. On commodity markets, Brent crude oil +4.00% to $40.29, gold+2.6% to $1,262, iron ore +1.3% to $53.57. AUD is at 0.7555 and the range was 0.7415 to 0.7561.

The 2016 Euromoney FX poll is now open for voting and may be accessed at www.euromoney.com/FX2016

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