For all the market worries about a U.K. housing bubble and U.S. financial stability, the only market shock yesterday was the central bank hawks that went missing in action. Despite expressing “surprise” that the market had not been pricing in higher rates for 2014, the Bank of England’s (BoE) Monetary Policy Committee (MPC) minutes revealed that its board members had voted unanimously (9-0) to keep benchmark lending rates unchanged. For the Federal Reserve Chair Janet Yellen and her crew, only two things ended up mattering: yesterday’s Federal Open Market Committee (FOMC) meet delivered a sharp downgrade to 2014 U.S. gross domestic product (GDP) (+2.8%-2.1%), and Yellen’s comments about the equity market being “fairly valued” and policy not being shaped by financial stability concerns. In truth, Wednesday’s outcome was hardly the “hawkish” tilt that many had been expecting, especially in the wake of stronger data like U.S. employment and inflation. By day’s end and in translation markets are to adhere to lower rates for longer despite record-high asset prices and improving economic data.
A major implication for the steady-as-she-goes Fed policy is the theme of subdued U.S. yields and the various asset classes’ ultra-low volatility that looks unlikely to change in the near term. With the Fed disappointing investors by not shifting to a tighter monetary policy, it has led to business as usual: support for the carry-trade currencies. The market should expect developed currencies like the Kiwi and Aussie to continue to benefit, while in the emerging market pairs category, both the ZAR and TRY should be coveted.
Fed Maintains Taper
Yesterday’s actual FOMC policy statement contained few surprises, maintaining its $10B per month pace of taper, giving partial acknowledgement of further improvement in the U.S. labor market, and a rebound in fixed investment. Despite the much higher consumer-price index (CPI) data on Tuesday, FOMC members repeated that inflation is running below the longer-run objective, deferring to the release of its preferred PCE (Personal Consumption Expectation) measure. Most importantly, FOMC staff projections cut 2014 GDP to +2.2% midpoint from +2.9% due to a softer first quarter; and affirmed growth numbers for 2015 and 2016. Unemployment targets for 2014 and 2015 were also lowered slightly but PCE projections were maintained for the next three years.
In hindsight, the Fed’s rate-path forecast was also little changed, despite the better-than-expected run of employment and higher inflation data — the vast majority of the policy members see the federal-funds rate no higher than +1.25% in 2015. During the post-meeting press conference, Yellen stuck to her script and in the era of transparency, she delivered a “measured press conference” stating that there is no mechanical formula for what is “considerable time” between the end of taper and the first rate hike. In effect, she was able to avoid the pothole trap of last time when “quantifying the lag as a six- month period.”
The Buck Takes a Beating
What do you give a market that has everything? You give them more of the same. Global equity bourses continue to eke out record highs on ‘cheaper’ cash. Global bond yields will remain under pressure, in turn flattening many Group of 10 yield curves. Lower U.S. yields do not making owning American dollars terribly exciting, but it does support commodity prices somewhat (gold through key resistance $1,282 per ounce). The mighty dollar is taking it on the chin as investors head stateside. Sterling has managed to hit a fresh five-year high, rising above £1.7020 (the highest level since July, 2009). The key resistance in the pair remains at £1.7030-50. The USD/JPY continues to hover below the psychological ¥102 handle, despite improved market risk appetite. The less-hawkish-than-expected Fed statement has driven one-month volatility to a record-low of less than 5%.
Today’s disappointingly weaker U.K. retail sales report spurs further squeezes of this week’s main EUR/GBP shorts. May U.K. retail sales fell -0.5%, while April was also revised down -0.3%. Yesterday’s initial EUR/GBP squeeze higher was being supported by the MPC’s 9-0 bank rate vote. Owning the pound was in vogue on the back of a surprisingly hawkish Mark Carney last week. However, this EUR cross is managing to drag the EUR outright higher (€1.3632). The EUR/GBP first line of resistance is €0.8033, while EUR outright it is €1.3645-50.
Will The Fed Disappoint The Markets Today?
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