A dovish FOMC statement, which indicated the Fed does not intend to raise rates this year, has seen the USD and rates fall sharply and US equities move higher. The Fed also said it would end its balance sheet reduction at the end of September. The NZD has broken through 0.69 after the FOMC meeting. NZ GDP and the Australian labour market report are in focus today.
As universally expected, the Fed kept rates on hold at 2.5% a short while ago. The Fed’s updated rate projections showed the median Fed official expected no change to rates this year (down from 2 hikes in the prior meeting in December) and one last hike in 2020. The median projection of the Fed funds rate for the end of 2021 is 2.625%, down from 3.125% in December. Eleven of the seventeen Fed officials projected no hikes for this year, signalling this is a fairly strong consensus on the committee. In our view, the Fed’s projections reaffirm that the Fed’s tightening cycle is likely over.
The Fed revised up its forecasts for the unemployment rate in the coming years (3.8% at the end of 2020 vs. 3.6% previously) while at the same time lowering its estimate of NAIRU, from 4.4% to 4.3%, signalling it expects the labour market to be less tight than what it previously thought. Its forecasts of GDP and inflation were marginally lower.
The Fed also announced that it would end its balance sheet reduction (so-called ‘quantitative tightening’) at the end of September, largely as expected. It will slow the pace of its balance sheet reduction from May. From October, maturing agency debt and MBS will be reinvested in Treasuries, subject to a $20b per month cap.
Market expectations heading into the meeting were that the so-called ‘dot plot’ would show one rate hike for this year. The Statement was therefore clearly on the dovish side of expectations and the market reaction has been swift. US rates have fallen across the curve and the USD is down across the board. The 10 year Treasury yield has broken out of its recent range and is down 8bps to 2.53%. The 5s30s curve has steepened 5.5bps to 65bps, its steepest level since late 2017, while the 2s10s curve is around flat. Market pricing of a Fed rate cut has risen, with a 50% chance of a cut now seen by the end of the year and a full rate cut now priced-in for mid-next year. Our thinking is that US rates will struggle to fall materially further from present levels, given the Fed’s cautiousness on further interest rate rises is likely to reduce the risk of it triggering a US recession, and a consequent easing cycle.
NZ’s 10 year swap rate closed at a fresh, record low of 2.3275% yesterday, and it will move lower again this morning after these moves in US Treasury yields (although the NZ GDP release this morning will also have an important say in where NZ rates close today). The Australian 10 year bond future has fall 6bps in overnight trading
The USD is down across the board post the Fed statement. The USD indices are down by 0.5-0.6% and are now nearing the lower-end of recent ranges. The NZD and AUD are amongst the outperformers against a backdrop of a weaker dollar and an increase in risk appetite, both up around 0.9% on the day. The GBP is the only major currency still down against the USD (-0.2%), although it has recovered the bulk of its earlier losses since the FOMC meeting.
The NZD has pushed up through resistance at 0.69 a short while ago, and currently sits at 0.6910. This leaves it towards the top of its recent 0.6650-0.6950 trading range.
US equity markets have bounced on the back of the dovish FOMC statement. The S&P500 was down around 0.7% at one point overnight, but it is now up 0.3% on the day now.
In other news, the GBP has underperformed, with the clock ticking down to the March 29th deadline for Brexit. After coming under pressure from Brexit-supporting members of her cabinet, Theresa May has requested only a short delay, to June 30th, from the EU. In response, EC President Donald Tusk said that a short delay was possible, but contingent on the UK parliament passing Theresa May’s Brexit bill in parliament (a vote is likely to take place early next week). May is due to make an address to the country shortly.
Market nervousness is likely to grow ahead of a possible third Meaningful Vote next week. May had appeared to be using the threat of a long Brexit extension to persuade Brexit hardliners to fall into line and vote for her deal. That she has now only sought a short delay means that this grouping of MPs is likely to vote against it ; the odds look stacked against it passing, at this stage.
There is considerable uncertainty around what might happen if May’s deal is voted down again. May implied she would resign rather than seek a longer extension, and the EU has said it wants assurances that there will be a new political process (i.e. elections, a second referendum or a new cross-party initiative) if it were to grant such an extension. Expect the GBP to remain volatile in the next few weeks.
In economic data, UK headline CPI was slightly higher than expected while core CPI was marginally lower; both measures are just below the BoE’s 2% target. The BoE meets tonight, and it is likely to remain cautious given the uncertainty around Brexit.
Oil prices have risen again, and the weekly DOE report revealed an unexpected decline in crude oil inventories. West Texas Intermediate increased 1.3% and touched $60 per barrel for the first time since November.
Attention now turns to NZ GDP released this morning and then the Australian labour market report this afternoon. We are looking for a 0.5% increase in Q4 GDP, slightly below the Bloomberg consensus of 0.6% (and the RBNZ’s 0.8% MPS forecast). Our NAB colleagues expect flat employment growth in February (market: +15k) and an unchanged unemployment rate off 5%, although they see the risk that it could tick up to 5.1%. The market prices close to one full rate cut in the NZ short-end and almost two full cuts for the RBA by mid-next year.
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