Fed Stops Printing Press-Market Caught Napping

The Federal Reserve ended its bond-buying program as expected, but it caught the market off-guard with a definite hawkish tint in its statement yesterday. Technically, the Federal Open Market Committee (FOMC) has finally closed the door on quantitative easing, or QE, with the $15B taper; however, never say never as bookies are already making odds that the central bank could crank up the money printing press if the U.S. economy happens to turn south once again.

Despite U.S. policymakers retaining the “considerable time” language, the statement released was deemed increasingly less dovish by the market, as it noted further improvement in “labor market conditions and diminishing underutilization of labor resources.” This has allowed the dollar to rally (¥109.03, €1.2581, £1.5988), U.S. yields to spike (American 10’s are at three-week highs, 2.34%), commodity prices to fall (gold down $21 to $1,203, Crude WTI $81.25) and U.S. stocks to flounder for the moment. Higher equity futures this morning would suggest that the market would prefer to focus on the upbeat status of the American economy rather than the potential of higher U.S. rates.

Labor-Market Slack Diminishes

The fact that the Fed has somewhat dismissed the recent turmoil in global financial markets, and has chosen to focus on the U.S. labor market, could indicate that the FOMC is prepping the market for a bigger change in December. One of the responsible roles for any central banker is to ease into a significant policy change. This helps policymakers eliminate any surprise shocks that could potentially harm an economy. The Fed does indeed need to get the market primed and ready for an eventual rate hike. All things considered, it has probably pushed back the first U.S. rate hike too far. Expect to see fixed-income traders bring rate-hike expectations further forward to mid-2015 perhaps, rather than the third or fourth quarters of 2015.

Investors to Shift Focus to ECB

Interestingly, the previous two Fed dissenters (Richard Fisher and Charles Plosser) voted with the rest of the FOMC, while a new lone dissenter (Narayana Kocherlakota) called for keeping the current target range for the federal-funds rate. With the deepest prices so far occurring on North America’s watch, early European session action this morning would suggest that the market remains somewhat hesitant to fully commit. It’s going to take a few trading sessions for investors to adjust now that the FOMC has finally begun limiting investors’ carry-friendly conditions. Expect investors again to be shifting their focus back to the European Central Bank (ECB). ECB officials know that they have to pick up the slack as they continue to face a serious deflation threat.

RBNZ Grapples with Inflation

The Fed was not the only central bank to catch market participants by surprise. Down Under, the Reserve Bank of New Zealand (RBNZ) hogged some of the limelight. Kiwi policymakers kept their rates on hold at +3.5% for the second consecutive meet, but the bank also removed its bias in favor of more tightening in light of the softer-than-expected inflation pressure. New Zealand inflation has slowed more than expected in the third quarter, hovering close to the bottom of the RBNZ’s +1-3% desired range.

Governor Graeme Wheeler indicated “a period of assessment remains appropriate before considering further policy adjustment.” What he left out in his statement this time around was the comment was that the central bank “expected some further policy tightening would be necessary to contain future inflation.” It was only natural that the NZD would come under pressure with the dovish tone (NZD$0.7816). With the RBNZ stating that the NZD rate “has yet to adjust materially to the lower commodity prices” has given fixed-income traders a green light to price in a +94% chance that Kiwi rates would not change over the next eight months.

In any event, following yesterday’s fireworks it’s back to North America where the attention shifts to the advanced release of U.S. third-quarter gross domestic product (GDP) data (expected: +3.1%). Being atop of U.S. dollar highs, it’s difficult to anticipate how much more momentum the greenback has at these levels. GDP is not expected to be much of a game-changer this morning — mind you, the market has been caught flatfooted already. Investors may need to wait for next week’s U.S. employment numbers to support the USD’s next leg higher.

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Dean Popplewell

Dean Popplewell

Vice-President of Market Analysis at MarketPulse
Dean Popplewell has nearly two decades of experience trading currencies and fixed income instruments. He has a deep understanding of market fundamentals and the impact of global events on capital markets. He is respected among professional traders for his skilled analysis and career history as global head of trading for firms such as Scotia Capital and BMO Nesbitt Burns. Since joining OANDA in 2006, Dean has played an instrumental role in driving awareness of the forex market as an emerging asset class for retail investors, as well as providing expert counsel to a number of internal teams on how to best serve clients and industry stakeholders.
Dean Popplewell