No rate hikes for three years is music to the market ears
US stocks bounced to the beat of a convincingly dovish Fed who stuck to the script by vowing to keep its easy-money policies in place for as far as the eye can see – or at least until the US economy fully recovers from the effects of the Covid-19 pandemic. Indeed, economic growth without rate hikes is music to the market's ear as the market reads that it's too early for the Fed to blink.
As bond and FX market bears are getting dished out a sliver of humble pie, investors are taking solace that the Federal Reserve Chair Jerome Powell delivered a strong and convincing performance here.
The market reaction is a good outcome for the Fed, which needed to walk the line through policy goalposts that are neither too dovish nor hawkish. Powell took no risks here, but by staying very calm and on the script and, notably with the market accepting it, he further cements the Fed's rhetoric credibility.
On the jobs outlook, Powell isn’t giving us much here. However, he underscores that it will take a long time to get these people back to work, given the numbers under consideration. He played the questions about the 2022 dots, and the SLR with a straight bat and the rest of the questions about jobs and the toolbox has pretty much stuck to the script he’s had in place for the last six months or so.
Dots trickled higher, but not enough to get the median to price a hike in 2023. The inflation projection for 2023 moved up a tick to 2.1, which was expected given fiscal stimulus and the improving outlook. But the key takeaway is that the Fed was convincingly dovish enough relative to market expectations; after all, no rate hikes for three years is a very comforting backdrop for risk sentiment.
The dots demonstrated the Fed's AIT commitment and cemented a dovish surprise because most FOMC participants still see rates on hold through 2023; only 7 participants project hikes, with 11 even at the Zero Lower Bound.
Interest rates on hold despite these higher economic forecasts demonstrates two critical messages: a practical commitment to the Fed's new average inflation targeting regime (i.e. accommodating overshoots after periods of undershooting), and a higher bar to shift hawkish communication this year – core inflation will now need to move above ~2¼% in 2021 for the Fed to change its tune. So, on the surface, risk assets appear to have been given a green light policy pass for 2021, at least for now.
What about the movement in the 2022 Dot?
From my seat, the movement in the 2022 dot is interesting: you now have four expecting a hike, up from one previously. With all the focus on 2023, and indeed the Fed's line that rates are on hold for a long time, that’s a significant change.
It's a significant shift that, once the dots get fully digested, you could think it will lead to a further pick up in the cat and mouse game between the market and the Fed that we’ve been highlighting lately.
Although there was a particular element of relief (and profit-taking) in the markets, the Fed's message and Chair Powell’s words alone shouldn't magically reverse recent market trends. The US economy is recovering, the Fed expects faster economic growth than it previously pencilled in, the unemployment rate could still fall further and faster, and inflation will overshoot for longer. And, as the dots indicate, more members are thinking about raising rates earlier. Once the relief trade is out of the way, there's not much to stop yields from rising again.
Oil prices that remain crimped by more countries in Europe suspending the use of the AstraZeneca vaccine didn't get much help from the EIA data as US crude inventories built by 2.4mb last week and are up 38mb over the previous three weeks due to low refinery utilization following the winter freeze-off; this walks back some of the more bullish for oil inferences from the API estimate the day prior.
Given the patchy recovery where consumption is taking off in the US but struggling in parts of Europe and around the globe, sentiment could be catching down to the economic demand reality.
Simultaneously, the omnipresent risk that OPEC and other oil producing nations could ease production curbs continues to provide a soft but remindful headwind.
With the Fed in no uncertain terms telling the market that it's far too early to blink, the US dollar has been under pressure post FOMC. Front rates yields continue to rally as Fed Chair Powell emphasizes the Fed is very serious about its average inflation targeting: "The only way to give credibility to the new framework is to do it”. He seems pretty pleased with himself and maybe he did have a hand in, with the dots not indicating a hike in 2023. The dollar dropping makes sense to me. Indeed, this is a risk supportive Fed and today's communication is confirming that.
The Malaysian Ringgit
The stars can't seem to align for the ringgit. Still, with the US dollar weaker across the board after the FOMC’s credible dovish messaging, it should outweigh the risk from slightly lower oil prices, given the underlying US dollar movements are the dominant factor. So, the MYR should see a bit of a relief rally today.
With the Fed delivering a credible Average Inflation Targeting twist by allowing the economy to run super hot above 2% and at the same time suggesting rate hikes are at least three years down the road, gold prices rose convincingly. This is leaving some bullion bears to admit an error in judgement and start to recant – at least for today.
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USD regains ground on April inflation figures to outperform low-yielding currencies; EUR/USD meets strong resistance; Gold looks increasingly attractive