Get 40% Off
🔥 This hedge fund gained 26.16% in the last month. Get their top stocks with our free stock ideas tool.See stock ideas

The Long And The Short Of The Fed

Published 12/15/2016, 02:38 AM
Updated 05/19/2020, 04:45 AM
USD/JPY
-
AUD/USD
-
US500
-
AXJO
-
JP225
-
EEM
-
MSCIEF
-

One would have liked to see the Federal Reserve’s economic and interest rate projections had they actually had a firmer understanding of Trump’s economic plans and his ability to efficiently execute on these. However, what we have seen are modest tweaks to their growth estimates that simply acknowledge the better data of late.

The fact the Fed still see the risks to the US economy as ‘roughly balanced’ has kept a lid on some of the moves in financial markets, but the fact that 11 of the 17 voting members are calling for ‘at least three’ rate hikes in 2017 reverberated around trading floors.

Janet Yellen was probed about an impending boost in productivity, largely as a result of potential fiscal stimulus from “Trumponomics”. In response, the Fed chair maintained a similar line as we recently heard from St Louis Fed President James Bullard, that being, until the Fed know the specifics they are simply not going to alter their projections and as it is they see 2.1% growth in 2017.

This estimate is modestly below the economist’s consensus of 2.2%, while US GDP in 2018 is expected to drop somewhat to 2%. Could it actually be that for the first time in years we are looking at a central bank who have to revise up their forecasts? Well, it was made fairly clear that the Fed still are on edge and believe there are a number of variables that could derail this recent run of form. There is clearly a lot of questions that need answers and of course the Fed are happy to show a degree of patience before reacting. That seems prudent.

3rd party Ad. Not an offer or recommendation by Investing.com. See disclosure here or remove ads .

The increase to their forecast on rate hikes has got the lion’s share of attention, with the Fed now forecasting three hikes in 2017 and 2018. The reaction on this has been quite dramatic, with the interest rate markets (fed fund future) now fully discounting two hikes in 2017, but also holding a 30% chance of three. We have seen a strong sell-off in US bond markets, noticeably in the five-year treasury, with the yield increasing from 1.88% to currently stand at 2.01%.

Given these dynamics in fixed income we have seen good buying in the USD, with USD/JPY hitting a session high of ¥116.78 and gold finding better sellers for a move below $1150. US banks initially rallied, but have since reversed and followed the broader equity markets lower. I would highlight that while US bond yields have pushed strongly higher, it has not been backed by a rise in inflation expectations and this has seen ‘real’ yields turn positive, which is being taken as a strong tightening of financial conditions and thus an equity negative.

US REITS are getting sold fairly heavily, but it’s worth highlighting that all sectors on the S&P 500 are lower, but the market is rallying into the close. The emerging market complex has been sold fairly aggressively, with the iShares MSCI Emerging Markets (NYSE:EEM) is down 2.1%.

AUD/USD has been hit fairly hard on the Fed projections, trading from $0.7500 to a low of $0.7413, clearly not helped by the selling in emerging market assets. Commodities are hardly an inspiration for those holding AUD longs, with spot iron ore falling 5.1% yesterday and weakness seen overnight in steel and iron ore futures. US crude is 2.8% lower from the ASX 200 cash close.

3rd party Ad. Not an offer or recommendation by Investing.com. See disclosure here or remove ads .

While there is still some way to go until the open of the Asian markets, it looks as though we may see a somewhat mixed affair in the fortunes of the markets. The ASX 200 should open around 5565, with the Aussie banks likely to open on a flat note, while BHP is eyeing weakness.

The Nikkei 225 will likely be the regions outperformer, given the rally in USD/JPY, but keep an eye on China as the strength in the USD is not going to be welcomed by the number of Chinese corporates who have to borrow from debt markets to fund much of the recently announced acquisitions.

Latest comments

Risk Disclosure: Trading in financial instruments and/or cryptocurrencies involves high risks including the risk of losing some, or all, of your investment amount, and may not be suitable for all investors. Prices of cryptocurrencies are extremely volatile and may be affected by external factors such as financial, regulatory or political events. Trading on margin increases the financial risks.
Before deciding to trade in financial instrument or cryptocurrencies you should be fully informed of the risks and costs associated with trading the financial markets, carefully consider your investment objectives, level of experience, and risk appetite, and seek professional advice where needed.
Fusion Media would like to remind you that the data contained in this website is not necessarily real-time nor accurate. The data and prices on the website are not necessarily provided by any market or exchange, but may be provided by market makers, and so prices may not be accurate and may differ from the actual price at any given market, meaning prices are indicative and not appropriate for trading purposes. Fusion Media and any provider of the data contained in this website will not accept liability for any loss or damage as a result of your trading, or your reliance on the information contained within this website.
It is prohibited to use, store, reproduce, display, modify, transmit or distribute the data contained in this website without the explicit prior written permission of Fusion Media and/or the data provider. All intellectual property rights are reserved by the providers and/or the exchange providing the data contained in this website.
Fusion Media may be compensated by the advertisers that appear on the website, based on your interaction with the advertisements or advertisers.
© 2007-2024 - Fusion Media Limited. All Rights Reserved.