Fed middle ground message leaves markets undecided

Fed’s "middle ground" message leaves markets undecided

Powell reassures but FOMC divided

Markets were briefly relieved that the Federal Reserve’s first rate rise, forecasts and comments under new chair Jerome Powell did not deviate significantly from best guesses.

Indecision

But U.S. shares flitted in and out of the red before closing slightly lower on Wednesday, and indecision carried on in Asian trading too. Despite Powell’s emollient tones during his first post-meeting press conference, traders were undecided over whether inflation could yet unexpectedly accelerate. After all, policymakers were less hesitant than in December to upgrade their growth outlook and the pace of that growth, amid tax cuts and government spending plans. Intended or not, they implied the door remained open for policy to accelerate with growth if need be. Furthermore, Federal Open Market Committee (FOMC) members were divided on whether three or four rate rises were appropriate in 2018.

Lots of tiny tightening

Changes in the committee’s policy statement added to the impression of FOMC dissonance on economic conditions. Inflation on a 12-month basis was now expected to rise “in coming months” rather than “this year”. More broadly, 2018’s growth projection rose 20 basis points to 2.7% and the FOMC took many opportunities to tighten at the margin. These included ‘dot plot’ rate projections pointing to one more rate rise in 2019 than in December to take the median to 2.9%, and a median long-run rate that inched up to 2.9% from 2.8%, breaking its glacial declining trend since 2012.

Fleeting reassurance

Powell downplayed the significance of a sharper push higher for 2020—to 3.4% from 3.1%—suggesting it looked far enough ahead to be treated as highly speculative. But the market’s reassured reaction was fleeting. The Fed chair also attempted to address perceptions that either economic growth might be in transition to a faster pace, or the Fed’s view might be, or perhaps both. Inflation might be “above or below” the Fed’s approximate 2% target at times he said, expecting only gradual upward pressure, despite sharp cuts in policymakers’ employment predictions. His Fed would take the “middle ground” he noted, and he was “surprised” that wage growth was so modest.

Treasury yields spike, then slide

The latter comment was enough to trim inflation-linked ‘breakeven’ Treasury rates, but the broader market was less convinced. At one point, the 10-year Treasurys sell-off looked on course to hoist yields sustainably back above 2.9%. But after a spike the rate returned to similar levels as beforehand. Some of the market’s wavering was likely due to seepage of deteriorating U.S. trade relations into Fed proceedings, amid reports China was readying its own tariffs. These could coincide with duties of as much as $60bn on Chinese goods to be announced on Thursday. Powell did not “expect changes in trade policy to have any effect”, though following conversations with business leaders, FOMC members reported that trade policy was “a concern going forward” for growth.

Dollar fade deepens

This helps explain the dollar’s fade from as high as ¥106.63 to as low as ¥105.58 during the Tokyo session. The move was broadly mirrored in other major pairs, though to a lesser extent, and inversely by gold, which started with modest gains on Wednesday but closed with a $21 rise. An uncertain take on the Fed and bearish geopolitical currents are likely to preoccupy markets for the rest of the week. This suggests the new chair’s first opportunity to provide a calming influence on markets could have gone better.

Looking ahead

Some of the focus shifts to Europe on Thursday amid the EU Summit at which officials will test the strength of a draft agreement with the UK for a transition period before it leaves the trading area. UK monetary policy will also be in the spotlight following a meeting by Bank of England policymakers. No changes are expected. However, following data this week showing an acceleration of earnings growth, sterling traders will be alert to strengthening signals of a rate rise in May, and the extent to which the MPC is minded to reinforce it with further tightening in the near term. Even so, U.S. announcements on trade policy could still take a large share of investor attention. Stock market volatility and further dollar selling are likely depending on the tone of accompanying statements from the White House.