December 19, 2014

Dovish or Hawkish? Take Your Pick

Risk appetite has continued to improve, with a promise from the Fed to be “patient” in normalising interest rates stoking equities.

Risk appetite has continued to improve, with a promise from the Fed to be “patient” in normalising interest rates stoking equities. The USD rose strongly in the immediate aftermath, but has since pared its gains.

There still seems to be some confusion about what the Fed communicated yesterday. To be sure, there is certainly a marked difference between the tone struck in the policy statement (modestly dovish) and at Fed Chair Yellen’s press conference (clearly hawkish). For ours, the end result is a Fed that has effectively said that it could begin raising rates as early as April 2015 i.e. much sooner than the market has been pricing (and continues to price). Bond markets are taking that message on board, with yields continuing to push higher. US 2- and 10-year bond yields now trade at 0.63% and 2.21%, up 12bps and 7bps respectively.

This does not seem consistent with the idea that a ‘dovish’ Fed has inspired equities to rally, as some commentators are suggesting. One doesn’t normally expect the share market to respond favourably to the prospect of interest rate hikes within the next six months.

Instead, we suspect that investors were heartened by (1) the confidence that Fed Chair Yellen expressed in the US economy, and (2) the reassurance that the coming hiking cycle will not be like the last, where there was a series of 17 consecutive 25bp hikes. The Fed seems more likely to raise rates in bursts, and then pause for assessment.

That, and a near-5% rally in crude oil prices, helped to steady equity investor nerves after a rather bleak fortnight. The Euro Stoxx 50 closed 3.3% higher, while the S&P 500 is currently up 1.9%, after finishing 2.0% higher post-FOMC yesterday. The VIX is down at 17.7, having gone above 25.0 earlier in the week.

The bounce in oil has proven short-lived, though, with WTI now down 3.8% for the day. Saudi Arabia’s oil minister rebuffed any ideas that the Kingdom and its fellow OPEC members had begun considering production cuts to stem the rout.

The USD has had a mixed performance overnight, after posting strong gains immediately after the FOMC. It lost ground against the GBP, thanks to a bumper UK retail sales report (+1.7% m/m vs +0.3% expected). GBP/USD is 0.6% stronger at 1.5670.

On the other hand, it strengthened against the CHF after the Swiss National Bank surprised markets by introducing a negative deposit rate. Our London-based colleague Gavin Friend has been warning of this for some time, noting that the CHF TWI’s recent gains had tightened monetary conditions. The SNB’s move looks to be in anticipation of the ECB easing policy early in the new year, which would have put pressure on the 1.20 floor on EUR/CHF that it has vowed to defend.

NZD also outperformed, though we are sceptical that NZ’s Q3 GDP report had much to do with it. Sure, the headline quarterly gain of 1.0% q/q was significantly better than the +0.7% the market had expected (but close to our our BNZ colleagues’ +0.9% pick). But a series of downward revisions to historical data meant that annual growth was slower than anticipated in Q3, as well as before that. Certainly there was nothing in the data yesterday to have RBNZ Governor Wheeler itching to pull the rate hike lever.

AUD has also lifted from post-FOMC lows, with the bears likely reluctant to push further on the string. However, 0.8200 looks to effectively cap rallies for now.

Coming Up

Tonight, we will look for the Richmond Fed’s Lacker on the wires, as the first Fed speaker out of the gates post-FOMC. On the data front, we have NZ net migration and business confidence, and the BoJ policy decision (no change picked).


On global stock markets, the S&P 500 was +1.70%. Bond markets saw US 10-years +7.37bp to 2.21%. On commodity markets, Brent crude oil -2.30% to $59.77, gold was +0.0% to $1,195, iron ore +0.5% to $68.42. AUD is at 0.8155.

• German IFO business climate 105.5 (105.5E, 104.7P)

• Philly Fed Index +24.5 (+26.0E, +40.8P)

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