September 21, 2017

Markets Today: That’s the way wind-down goes

The FOMC this morning announced as expected the formal start to winding down its balance sheet to commence next month.

It left its Fed funds rate unchanged at 1-1.25%, also as entirely expected.  While this starts another chapter in what’s been a momentous decade since the GFC, the market was also – perhaps more – attuned to the FOMC forecasts for the Fed funds rate and the economy that were not materially altered for this year and next.  Market reaction has seen a relief rally in the USD and a modest lift in Treasury yields.

Come next month, as the Fed’s holdings of Treasury and mortgage-backed securities mature, the Fed will allow these to run off their balance sheet, but up to stated monthly caps.  As they communicated in June, those caps start for the first three months at $6bn/$4bn for Treasuries/MBS, then the caps rise each quarter until they reach $30bn/$20bn per month in a year’s time.  There’s no active selling of securities per se, but a passive run-off of the Fed’s holdings.  Yellen noted that the hurdle to the Fed changing tack with this program is high.  There would have to be a “material” or large change, the Fed resorting more likely to use rates.

As for the Fed’s dot point forecasts of its Fed funds rate, the median still has one more for this year taking it to the 1.25-1.50% target range (one bold member forecasts there will be two!) and three more next year that would take Fed funds to 2.00-2.25%.  That was the expectation back in June and the big dollar liked that.  The median forecast at the end of 2018 was left unchanged at 2.125%, while it was lowered 25 bps for 2019 with one more hike expected after that in 2020.  The longer term projection for the Fed funds was revised down from 3.00% to 2.75%, FOMC members down-scaling their expectations for what the neutral real Fed funds rate will be over the longer term.  It’s currently believed to be around zero in real terms which with a 1½% core PCE inflation rate would be a nominal rate of 1½%.

That brings into play where the Fed sees growth and inflation over the next year or two, driving those rate views.  Growth for this year was shaved 0.2% to 2.4%, then running close to 2% for next two years.  Unemployment was lowered by 0.1%, but so was inflation for next year to 1.9% after being expected to land at the end of the year at 1.5% (-0.2% cf June’s forecast).

In her press conference, Yellen spoke about how recent inflation readings had been something of a “mystery”.  She said the Committee does not fully understand why it’s remained so low, how much is structural, how much is transitory.  The data will tell no doubt.  She went on to remind the press conference that monetary policy acts with a lag and that wage and price inflation is still expected to rise.  They also expect that over time, there will likely be some increase in the neutral rate requiring additional rate rises, as in their forecasts.

The USD was losing some ground in the APAC session and overnight, recovering some lost territory after this morning’s announcements.  Since the Tokyo close, the DXY is up a net 0.66%, Kiwi and Aussie outperforming, the former getting a boost after the Colmar-Brunton poll suggested the Nationals had regained the lead in the polls for Saturday’s election.  The commodity complex was mixed to higher overnight, oil getting a boost from the news that gasoline stockpiles in the US are at 22m lows.  Yellen also said that the Fed would look through the data impacts from the hurricanes and that they were not expected to affect longer term economic performance.  The AUD is at 0.803 after testing 0.81 pre-FOMC.

In other news overnight, UK Retail Sales in August were much stronger than expected, up 1.0% in August (+0.1/0.2E) supporting sterling before the FOMC.

Coming up

There are more key data and events over the next 24 hours.  First is NZ’s Q2 GDP, our BNZ colleagues (and the market) looking for q/q growth of 0.8% after 0.5% in Q1, annual growth steady at 2.5%.  Yesterday’s balance of payments report suggested some upside risk from trade.  Then RBA Governor Phil Lowe is speaking in Perth at lunchtime at 13.10 Perth time.  His speech is to an American Chamber of Commerce in Australia event, titled “The Next Chapter”.  This could be a discourse on the further progression of the Australian and/or global economies, the global and domestic interest rate cycle, on currencies, or the WA/Perth story or even the US/Australia connection and growth outlooks.

Also today is the BoJ, recent outcomes mostly rather pedestrian ones for the market.  But remember, the BoJ is hoping the Yen (the USD) will aid their effort to inject some price reflation into the economy while “Yield Curve Control” is aimed at restricting yields to about zero.  It remains to be seen whether Fed policy will be a hindrance or a help, US inflation readings doubly important.  Governor Kuroda could be questioned on the Fed and BoJ implications at his press conference (16.30 AEDT).  And there are two new MPC members too.  Dissent?: possible, but unlikely.

Draghi is speaking tonight.


On global stock markets, the S&P 500 was +0.06%. Bond markets saw US 10-years +2.30bp to 2.27%. In commodities, Brent crude oil +1.92% to $56.2, gold-0.5% to $1,301, iron ore +1.2% to $69.65, steam coal -0.3% to $97.95, met. coal +0.2% to $206.50. AUD is at 0.8029 and the range since yesterday 5pm Sydney time is 0.7986 to 0.8102.

Good luck.

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