fed hawkish on semantics but yen gets last word 121582015

The US dollar rallied against all currencies with the exception of the Japanese yen, which was the overall winner following today’s release of the FOMC statement, which can be best summed up as less dovish than expected, or slightly more hawkish than anticipated. The resulting declines in the stock market – 195 pt loss in the Dow Jones Industrials Index—meant a 2.75% decline in two days, which is the biggest back-to back drop since February 2014.

Hawkish on semantics

The Fed upgraded its assessment on the economic growth to “solid” from “moderate” in the December statement and improved the wording on job gains to “strong” from “solid”, while restating that slowing inflation remained “transitory”.

The hawks were also cheered by the Fed’s removal of “considerable time” reference to low rates from the statement, after displacing it around in December (not removing it as was erroneously stated by most pundits).

International developments finally recognized

Finally, the FOMC included “international developments” to the existing list of “labour market conditions, indicators of inflation pressures and inflation expectations” as factors determining the timing of the hike in fed funds rate. We will find out next month upon the release of the FOMC minutes the extent of international factors considered by the Fed. Surely one of them is the prolonged decline in global inflation, about which the bond market is already worried as it sent 10-year yields near the two year lows of 1.6966%.

What’s the latest on Fed’s flip-flop on the US dollar?

While we did not expect the Fed statement to mention the impact of USD strength, we will surely find this out in the minutes. The Federal Reserve’s consistency in changing its views on the impact of the rising US dollar is not so different from its changing views on unemployment and inflation. The chart below summarises the FOMC’s discussions on the rising USD over the last three meetings.

At the September 16-17 meetings, the Fed indicated “concern” over the slowing Eurozone growth, the resulting rise in the USD and its “adverse effects on the US external sector”.

But in the December 16-17 meetings, when the strength of the USD added another 4-5%, the Fed changed its mind, saying it “revised down its estimate of how much the appreciation of the dollar since last summer would restrain projected growth in real GDP”.

Considering the greenback rose an additional 6-7% since January, the FOMC would have no choice but to acknowledge the negative impact on US earnings, as it has been publicly announced by the likes of Caterpillar, Dupont, Microsoft and Procter & Gamble. And with over 40% of earnings of S&P500 companies arrive from foreign sales, the Fed cannot ignore further USD strength at a time when disinflation is imported from China and Europe

Yen gets the last word

And despite all the headlines about USD strength, the Japanese yen has been the clear winner, rising over the USD since the start of the year. As long as bond yields continue to be dragged down by bond traders’ preoccupation that the Fed hawkish intentions will risk deflation and endanger growth, the Japanese currency will push higher as the world’s biggest provider of capital goes for the “home bias”.

Have we told you lately that we don’t see a Fed rate hike in 2015? Just checking.