FOMC and market reaction
Looking through the headlines of the Fed statement, there’s not much change. Rates are on hold, and it’s committing to continue bond-buying until there’s "substantial" further progress on its goals. But we knew that. On the dots, the median view is unchanged, as is the distribution in 2022; there are now five who see lift off in 2023, up from four in the previous set.
Looking at the immediate price action after the FOMC statement, the obvious disappointment on the lack of reference to an extension of the weighted average maturity (WAM) of asset purchases was painted all over the market’s initial less dovish knee jerk reaction. However, in the post FOMC scrum, Chair Powell struck a sufficiently cautious note that completely plastered over opening any debate to the timing of monetary tightening. And it’s on inflation where Powell is firmly dovish in tone, saying it will take a long time no matter what the Fed does (e.g. increasing asset purchases). They won’t pre-emptively raise rates until they see inflation reaching 2% and on track to exceed 2%. To be clear, this is not new, but vaccine optimism certainly hasn’t shifted the tone on this at all.
And in the final FOMC meeting of an extremely contentious four-year relationship with the White House, it was the FOMC that got the last word – a dovish one that might even put a smile on the overly grumpy outgoing President Trump's face. So, with no change in the pace of asset purchases or WAM extension, there was a tweak to forward guidance language: the Fed committing to continue asset purchases "until substantial further progress has been made toward the Committee's maximum employment and price stability goals." Risk sentiment should remain happy.
The markets look set to head over the year-end finishing line complemented by a modestly optimistic turn in FOMC forecasts. Still, with a significantly larger overshoot of inflation built into 2023, as the FOMC will keep rates low even beyond when the whites of inflations eyes become visible, the FOMC has successfully communicated that it’s prepared to allow the economy to 'run hot' in the future without prematurely tightening policy. Bond investors are validating the Fed's average inflation targeting framework that, in turn, is supporting pro-reflation trades: long oil, industrial commodities and a rotation to value in stocks.
Despite signs of year-end investor fatigue setting in, it was a risk-on session that gathered pace with further positive Brexit headlines, adding momentum to the US stimulus talks' initial velocity. But it was backyards getting busy in Europe that caught the market's eye. German industry is bouncing back energetically from the recession as things are starting to get busy quickly. Even although prior PMI pointed to a positive trend, today's print surprised the market, which strengths the Euro bulls’ view that a strong recovery is not yet in the price.
Coming amid widespread lock-down measures, there was further evidence that activity has adapted more quickly than expected to Covid conditions and that the economic cost of second and third waves might be less than expected. Beats on the PMIs for the UK and Japan rounded out the bullish global data backdrop, whereas the US prints were more mixed.
Those are mere green shoots compared to what we could see in the spring once the most vulnerable are vaccinated; falling mortalities allow faster reopening where the economic recovery is bound to happen multiple times quicker.
With much of the vaccine and stimulus optimism and the Fed confirming what we all pretty much knew, I’m left wondering how much energy remains in the bullpen as we enter the final inning of the year. We might see a bit of a fish and chips type rally on a US stimulus bounce where folks roll up their "fish and chippy" takeaway in the tabloid headlines and then toss it in the bin when they get home.
Still, given that we’ll know whether a hard Brexit is happening by year-end, a risk-on leg on Brexit news is likely in the next couple of weeks. Suppose that were to be accompanied by a fiscal deal in the US, and given that several big Wall Street and High Street traders are looking to position for the 'reflation trade' going into Q1 2021, a material shift higher in all tapes is quite possible.
Oil markets got pretty revved up by all the factory yard activity going on in Germany and positive PMI around the globe, which suggests the economic effects of the second and third wave is not nearly as problematic as feared.
But the clear sentiment "tell" is that crude is trading just short of its recent highs, despite the growing restrictions being imposed in response to Covid-19 infection waves. And keenly important for sentiment to hold to the current form, Washington appears to be edging towards a new stimulus bill in the aftermath of President-elect Biden being confirmed by the electoral college and several senior Republicans acknowledging his victory.
US policy inputs are critical to the view, which will likely deliver the final market hurrah for the year (a skinny Brexit deal notwithstanding). While we await the US stimulus package that will include a second round of stimulus checks and could be completed by the end of this week, the FOMC has successfully communicated that it’s prepared to allow the economy to 'run hot' in the future without prematurely tightening policy. Bond investors are validating the Fed's average inflation targeting framework that, in turn, is supporting pro-reflation trades into long oil trades and where oil should find a modicum of support from the weaker US dollar.
The market remains in buy on dip mode ahead of likely US stimulus bounce as the downside risk remains triple inoculated by the vaccine, US stimulus expectations and OPEC's unwavering commitment to defend oil prices.
US crude inventories fell 3.1mb w/w, partially undoing some of the 15.2mb increase of the previous week. Sharply lower crude exports largely drove the previous stock build, but these normalized somewhat.
Today's inventory numbers were a lot more benign than expected. However, a large draw in oil stocks and smaller-than-expected builds in gasoline and distillates were not enough to call this a bullish report. Today's totals only marginally reduce the gigantic builds we saw last week.
Gasoline traded higher despite the fifth-straight week of builds while demand remains subdued. Distillates demand for diesel remains strong, moving closer to 2019 levels; goods transportation is the main driver for both rail and road freight. Demand for jet fuel demand is up week-on-week but down about 40% from pre-pandemic levels.
There was a rebound in exports this week after the largest decline on record last week, partly due to bad weather in the Corpus Christi and Houston areas. Crude production fell to 11 million barrels a day – the first drop since late October.
Algo headline knee jerk aside, I think the FX market had the FOMC event priced to perfection.
Veterans on the Interbank desk know the Fed tends to deliver dovish outcomes during easing cycles, even when financial conditions are already extremely loose. I think the Fed has made attempts to bolster the AIT framework's credibility without really doing all that much. Implied volatility was and is very low, with 10y nominal yields trading in ever-tighter ranges in recent weeks, real yields are lower as bond investors are validating the Fed's average inflation targeting framework that, in turn, should keep the dollar on a weaker tangent.
It’s bad marketing on my part not to leave you without a tradable call to action, so with Wall Street and High Street big trading houses likely topile into the big reflation trades of 2021, there’s a higher chance for the dollar to get slammed with the FOMC not looking massage the Fed funds rate higher well into 2023.
It’s 4am as I write this and I’m yet to do my daily 10km run which normally gets me thinking on a more balance note, so more on the dollar later!
Currency Manipulator Lists (“Who cares?” seems to be the market's reaction)
The US Treasury deemed both Switzerland and Vietnam currency manipulators in its semi-annual FX report. It indicated punitive action could follow unless "bilateral engagement" over the next year satisfies its concerns. Market reaction was muted, and adding Switzerland to the list is meaningless; the SNB uses CHF intervention as a monetary policy tool and doesn’t care what the US Treasury thinks.
The US Treasury has released its much delayed “currency manipulation” report, which focused on the period between July 2019 and June 2020. It designated Vietnam and Switzerland as currency manipulators. It also placed 10 economies on the Monitoring List; three are new additions – Thailand, Taiwan and India – and they join familiar names: China, Japan, Korea, Germany, Italy, Singapore and Malaysia. This will all be very much ignored, given the Biden administration is less likely to pursue aggressive action.
For the ringgit today, the easing of domestic political risk with the passage of the budget, stably higher oil prices, and the Fed holding rates lower for longer should keep the ringgit on an even and bullish keel. But given investors’ profit-taking, year-end proclivities could turn things quiet; I would suggest the best is yet to come for the MYR as we roll into 2021 where commodity prices should continue to reflate the globe.
Gold jumped as the Feds will allow inflation to run hotter through 2023 without tweaking rates higher as they are prepared to keep rates low even beyond the point when the whites of inflation’s eyes become visible.
For gold concerns, the optimism over a vaccine is being dulled by the immediate issue of rising case counts on the ground. But as we approach the key $1,875 level, the vaccines rolling out can dent gold's rally, as does the expert call for herd immunity as soon as Q2 2021. So, while gold is hugely supported by the Fed’s hold the course policy, it’s inflation that will now be expected to do the heavy lifting to both push the dollar lower and inflation break even higher, which would send gold vectoring higher.
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Investors are still digesting the latest statements from the US central bank, which surprised markets with a far more hawkish stance than expected