Fed adds state-contingent forward guidance to rates outlook. Market takes that in its stride, expects rates to remain low for many years. NZ debt funding program lowered, pushing long NZGB yields lower

There has been only a small market reaction to the Fed’s updated policy statement, even as it included forward guidance on rates linked to inflation and employment outcomes. US equities have held on to its gains, and US bond yields continue to track sideways. Currency movements have been mostly modest, with the GBP continuing to recover and the NZD adding slightly to gains seen yesterday.

The US Fed left policy settings unchanged but there was a major re-wording of the policy statement to reflect the new inflation and employment objectives. To that end, forward guidance was enhanced, although it looks deliberately vague to give the Fed plenty of flexibility in the years to come. 

The Fed will maintain the Fed Funds rate within the 0-0.25% target range “until labor market conditions have reached levels consistent with the Committee’s assessments of maximum employment and inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time.” There was also a slight rewording with regards to the QE programme, some might say giving it a slightly more dovish tilt, with the bond purchases not only supporting market function but also to “help foster accommodative financial conditions”. However, those looking for more explicit guidance of increased bond purchases would have been disappointed.

Surprisingly the vote wasn’t unanimous, with two dissents. The more credible one was by Kaplan, who wanted more flexibility with regards to the guidance on rates, while Kashkari’s dissent was a bit of a mishmash, seeking a reference to “core” inflation being above 2% on a sustained basis.

The Fed’s economic projections still show a sobering outlook, but not as bad as previously projected, given the recent run of stronger economic data. The dot plot of rate projections showed a strong consensus for the Fed Funds rate to stay near zero through 2023.

The market took the statement as “business as usual”, not changing expectations that US rates will remain near-zero for many years to come, a supportive policy backdrop for risk assets. The S&P500 has showed modest gains throughout the trading session. The US 10-year rate is at 0.69%, near the top of its overnight trading range, but little changed for the day. The USD BBDXY index is flat for the day, showing a small recovery during Fed Chair Powell’s press briefing.

In other news, top US health officials have weighed in on the likely timing of widespread vaccination of the US public. The deputy chief of staff at the Dept of Health and Human Services suggested that with FDA approval before year-end, every American should be able to get vaccinated by the end of March. The more well-known Fauci said Q1 timing was aspirational and more likely widespread vaccination would be available mid-2021. This view seemed to be backed up by CDCP director Redfield who suggested late Q2, or Q3 next year.

In economic news, US retail sales data showed further recovery, with ex auto and gas sales up 0.7% m/m in August, a much-reduced pace compared to recent months and lower than expected. Sales continue to be boosted by the reopening of stores, but the expiration of the supplementary $600 weekly unemployment benefit was a likely key drag on further recovery and will hinder further recovery. Meanwhile the US housing market remains hot, with the NAHB index rising to a record high, up 5 pts to 83.

In currency markets, GBP continues to lead the way, up 0.5% to near 1.2960, recovering for a third day after last week’s rout, despite further political brinksmanship on Brexit. UK PM Johnson suggested that EU negotiators were not acting in good faith. He said that with no trade deal, the EU would face “formidable” tariffs. EC President Ursula said that with every day that passes, the chances of a timely agreement do start to fade and that the Withdrawal Agreement cannot by unilaterally changed, disregarded or dis-applied.

The NZD caught a bid after the release of the pre-election economic and fiscal update and has extended its gain overnight to reach around 0.6760 before fading. In the fiscal update, Treasury’s growth outlook showed a shallower recession than expected back in May but also a slower recovery period, with an assumed closed border, bar some safe travel zones, through to the end of next year. The unemployment rate peaks at a lower 9.8%, but stays high for longer, still above 7½% by June 2022. Large underlying fiscal deficits are projected for some time, albeit declining from 10½% of GDP in 2020/21 to 3½% by 2023/24, sending net core crown debt to 55½% of GDP by that end point,

In a surprise move, the NZ Debt Management reduced the scale of the FY2020/21 government bond programme by $10b to $50b and next year’s projection by $5b to $34b. A new May 2028 bond is expected to be launched via syndication before the end of this year. The funding requirement will likely see reduced tenders, allowing the RBNZ to scale down its weekly LSAP offers. The announcement saw a bid at the long end of the government curve, seeing the 10-year bond close down 3bps to 0.58%, with some curve flattening, against a backdrop of little movement in the swaps curve.

In a historic deal, Auckland City Council completed a $500m issue of a 30-year “green” bond offer, the longest nominal bond issued in the NZ market. The yield was at 2.95% and met strong demand, with yield-starved investors left on the sidelines.

The NZD is stronger on the key crosses apart from NZD/GBP nudging down below 0.52.  AUD is barely higher for the day, seeing NZD/AUD lift to 0.9220. EUR has been the weakest of the majors, down 0.3% to just over 1.18.

It is another action-packed economic calendar over the coming 24 hours. Domestically, there will be keen interest in how much the restrictive lockdown plunged the NZ economy into recession. Our estimate for Q2 real GDP is for a 13% contraction, but any figure between minus 10-20% is possible, given the inherent measurement difficulties. The deeper the contraction the steeper the measured rebound for Q3 will be so we’re not too fussed about the reported outcome and neither should be the market. Australian employment data always present the opportunity for trading opportunities in the FX market. BoJ and BoE meetings aren’t expected to rock the boat, with unchanged policy settings expected by the consensus. Tonight sees the release of a number of second-tier US economic releases, with most interest in whether initial jobless claims can nudge down further.