It appears the Fed may indeed have decided that enough is enough with respect to the constant questioning and criticism it has received about falling behind the market. After the CPI inflation measure was observed at 5% and the Fed’s preferred PCE measure came in close behind it, yesterday’s decision was always going to present the opportunity for volatility and change. With most of the market having convened around the idea that the Fed would continue to tread the line of caution and avoid signals of tapering, the Federal Reserve last night wrong footed markets with a dramatic consequence to the Dollar and a spillover into Dollar-sensitive currencies.
The Fed last night held rates as expected with no immediate change to its asset purchase programmes. It will continue to purchase treasuries at an enormous $80bn per month with mortgage backed security purchases coming in at an unchanged $40bn per month. In other words, the Fed confirmed it will still continue to throw the kitchen sink at financial markets with the aim of supporting the financial and economic recovery from the coronavirus pandemic. What did change was the forecasted path of interest rates displayed in the so-called ‘dot plot’. The key feature of last night’s decision came in the Fed’s outlook for 2023 with officials now seeing two rate hikes that year. The number of submissions from the FOMC seeing a rate hike next year also grew in number highlighting a truly changed sentiment among monetary policy setters.
Overall therefore the message was a resounding confirmation that inflation and consequent policy normalisation is front and centre of the Fed’s thinking. Despite the market already convening around the consensus for two rate hikes in 2023, receiving that confirmation from an until now ultra-dovish monetary institution was enough to develop expectations further. Obscuring the Fed’s intentions, Jay Powell also noted that if general inflation expectations continue to runaway from the Fed’s target, policy responses could have to change faster.
The last key observation from last night’s decision was the Fed’s macro economic outlook. The central bank upgraded growth for this year from an expected 6.5% to 7%. Arguably more important than this was the Bank’s core inflation outlook which showed sustained price pressure in the 2-3% region over the medium turn creating the expectation for further near term support as the recovery gains traction. The overall picture therefore, bond yields higher, Dollar higher and equities lower. A rising Dollar has also put a hold on EM currency strength as expectations of global policy normalisation stunts their relative appeal and, in many cases, harms their fundamentals.
Already, there has been a spill over at the European open to other geographies showing the market may be viewing the Fed’s departure from its previous policy stance as only one shift in a global paradigm change. The sell-off seen in US fixed income and equity markets is being mirrored so far this morning across Europe. There are other G10 central banks publishing their monetary policy decisions today including Norway and Switzerland and these decisions will be critical in answering the question of whether the Fed’s decision is a reoccurrence of the America first theme or a materialisation of a global change. The latter of course will create a more meaningful and broader shift within FX crosses.
Discussion and Analysis by Charles Porter