Stuart Talman reviews the US Fed update. Fed delivers widely expected on-hold decision, maintains tightening bias. Bond yields fall on soft ADP/ISM Mfg & Treasury refinancing announcement

By Stuart Talman, XE currency strategist

As universally expected, the Fed has delivered back-to-back on hold decisions, extending September's pause through November and into the final FOMC meeting for the year, to be held on 12-13 December. The key takeaways:

• The Fed maintains a 5.25%-5.50% Fed Funds rate
•  Acknowledges tighter financial conditions
• Maintains tightening bias

The market has leaned towards a modestly dovish interpretation despite some clearly hawkish comments from Fed chair Powell during the Q&A section of the FOMC presser.

US treasury yields are lower, the yields on the benchmark 10-year note has marked fresh intraday lows following the conclusion of the press conference, falling to a two week low through 4.75%.

In turn, the dollar is weaker against most of its major peers, logging its largest decline against the Australian dollar (AUDUSD up around 1%), whilst the New Zealand dollar has added over half-a-precent, again ascending back into the 0.5840/80 resistance zone we have been monitoring.

The dollar's decline was not solely attributable to the FOMC decisions/statement/presser, as the earlier release of the softer-than-expected ADP Employment change and ISM Manufacturing PMI weighed on the dollar, lifting the Kiwi to its intraday high a pip or so shy of 0.5860.

During Powell's presser, NZDUSD chopped around before climbing from the 0.5820's to start Thursday's local session in the 0.5850's.

So, what were the noted outcomes from the November FOMC meeting?

Starting with the statement, it was mostly a carbon copy of the September statement, retaining references to the committee remaining highly attentive to inflation risks and the need to take into account the cumulative tightening of monetary policy, lag effects and economic and financial developments.

There was one notable addition to the statement: the inclusion of financial in reference to tighter financial and credit conditions for households and businesses, that is expected to cool economic activity and therefore inflation.

The September statement solely referenced credit conditions.

One of the important questions for today's FOMC meeting - how much weight Jerome Powell and his FOMC colleagues would place on the recent tightening in financial conditions and would the aggressive rise in longer dated bond yields supplant the need for the Fed to further lift the target rate.

Whilst the reference to tighter financial conditions in the statement suggests officials acknowledge the bond market has done the late-cycle work for the Fed, Powell's answers during his Q&A session indicate that conclusion may be presumptuous.

When pressed on the Fed's psyche given tighter financial conditions, Powell confirmed that he and his fellow FOMC members are still not confident that financial conditions are sufficiently restrictive. In addition, he stated that financial conditions, whilst notably tighter would need to remain so for a sustained period to potentially remove the need for additional rate hikes. Powell commented: "We don’t know how persistent tighter conditions will be."

Powell was also asked whether the FOMC committee still retained its tightening bias. The Fed Chair confirmed this was the case stating, " The question we're asking: should we hike more."

The immediate reaction to these hawkish comments - the 10-year yield firmed 4-5 bps, climbing back through 4.80%, the dollar firmed, NZDUSD retreated from north of 0.5840 to within a couple of pips of 0.5820.

However, the reaction faded through the remainder of Powell's presser, an indication that the market favours the view that the Fed is done, due in large part to the tightening in financial conditions since the September FOMC meeting.

Market pricing currently assigns a 20% probability the Fed hikes 25bps at the 13 December FOMC meeting.

It will be interesting to observe how expectations evolve as we monitor both the upcoming macro data flow and the path for longer dated US treasury yields.

Earlier in the session, the US Treasury’s quarterly refunding announcement flagged a slowing in the pace of longer-dated debt issuance, driving the 10-year yield lower from near 4.90% through 4.80%. For the time being, the yield appears to have marked a swing high around 5.02% on 23 October.

Should the 10-year yield extend lower towards 4.50% whilst the macroeconomic data flow continues to report a resilient US economy amidst persistently high inflation, the Fed will likely resume tightening.

We caution against calling an end to the US dollar's dominance.

Looking to the day ahead, the main event is the Bank of England's interest rate decision, widely expected (61/73 polled economists via Reuters expect no change) to maintain a 5.25% policy rate. September's on-hold decision was a tight 5-4 vote split. Following softer-than-expected CPI data for August, the BoE vote is likely to be more one-sided.

Having rebounded over 6% from 7-year lows in the 0.4630's in late August, NZDGBP has pulled back from above 0.49 to range between 0.4770 and 0.4820 over the past two weeks. We expect the pair to continue to track sideways through the reminder of the year, ranging between 0.4750 and 0.4900.

Following a busy Wednesday, a light US economic calendar delivers weekly jobless claims.

Once again probing the 0.5840/80 resistance zone, we'll be monitoring NZDUSD price action to confirm if NZD buyers can drive the pair through this critical region. A successful ascent shifts the short-term bias from negative to neutral.

Stuart Talman is Director of Sales at XE. You can contact him here.