The FOMC meeting was a fairly exciting affair, with the market taking the lack of upward movement in 2023 dots as relatively dovish.
A bull-steepening in the UST curve, a weaker USD, and rallying equities suggest a job well done as the Fed is succeeding in convincing markets that it will remain behind the curve by not reacting to an improving economic trajectory.
The overarching message from the Summary of Economic Projections and Fed Chair Jerome Powell's press conference was of greater optimism on the outlook but a central bank that is not in a hurry to raise rates.
This mix is favorable for risk assets until investors start to question the Fed's evidence-based approach as incoming data improves. Until then, the USD looks set to weaken, with high-yielding currencies (e.g. BRL, COP IDR, MXN) and regional underperformers (e.g. KRW) in the driving seat.
The Fed's average-inflation targeting framework can be described as intentionally setting itself behind the curve, or more respectfully, as adopting an evidence-based rather than an anticipatory monetary-policy approach.
Aussie On A Ripper
Australian employment data for February was much stronger-than-expected at +88.7k vs +30.0k consensus. The unemployment rate also fell to 5.8%, from 6.3%, even as the participation rate remained 66.1%. The split between full-time and part-time is AUD-positive, being entirely driven by full-time work (+89.1k). Part-time jobs contracted 0.5k.
This week's RBA minutes suggested that the central bank views the labor market as recovering, only very slowly; but this data-set points to a more rapid improvement. Coupled with a dovish Fed that is USD-negative for now, an improving domestic picture is putting AUD/USD on the front foot this morning.
Forex By The Book
The March FOMC meeting was arguably a critical test of the Fed's new policy framework credibility. If the initial market reaction proves lasting, then the Fed managed to balance the message of a strengthening economy and a moderate inflation overshoot with the dot plot showing no hikes through 2023.
In a sense, this is 'old school' central banking as the Fed can control the curve's front end by inaction, i.e., delaying rate hikes and let markets find equilibrium at the long end.
For FX and gold market concerns, the importance of the new framework is probably higher now than during the pandemic back in September when the Fed's reaction function to inflation overshoots seemed to be little more than an academic discussion rather than a policy put
Contrary to popular opinion, it's not relative growth differentials that typically drive the dollar. In the early stages of the recovery, it's mainly about the overall rebound in growth and equities, which usually leads to more substantial risk-taking proclivity and a weaker USD due to rotational capital inflows into non-US assets.
Rates do matter, but tend to be more significant during the mature end of the recovery mainly because of Central Bank tightening and easing bias. As long as the Fed delays and inflation cooperates, the post-pandemic global growth upturn should weigh on the dollar.
A Risk-Supportive Fed was convincingly dovish enough to bounce markets; after all, no rate hikes for three years is a very comforting backdrop for risk.
Markets
No rate hikes for three years is music to market ears.
US stocks bounced to the beat of a convincingly dovish Fed who stuck to the script, 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 traders unanimously read that it's too early for the Fed to blink.
With Bond and FX market bears getting dished out a sliver of humble pie, Investors are taking solace that Powell delivered a strong and convincing performance here.
The market reaction is a good outcome for the Fed, who needed to walk the line through policy goalposts that are neither too dovish nor hawkish. Powell took no risks here, mind you, but by staying very calm and on the script, but as notably with the market accepting it, he further cements the Fed's rhetoric credibility.
On the jobs outlook, Powell is not 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 has had in place for the last six months or so.
Getting Dotty
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 also demonstrated the Fed's AIT commitment and cemented the dovish surprise. 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 demonstrate 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 their 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 have now got four expecting a hike 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 is 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 have been highlighting lately.
Although there was a particular element of relief (and profit-taking) in the markets, the Fed's message and 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 penciled 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 Markets
Oil prices that remain crimped by more countries in Europe suspend the use of the AstraZeneca (NASDAQ:AZN) 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—walking 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 worldwide, 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.
Forex
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 Powell emphasized 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 seemed 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 yesterday'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.
Gold Markets
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, leaving some bullion bears to admit an error in judgement and start to recant at least for today.
Assuming 'steady dovish state' after the FOMC holds, the $1761 spot could be the next focus. Friday is GLD option expiry, and the USD165 strike (USD1761 spot) has 530k oz in open interest, providing a target for speculators to throw darts.
However, after the relief rally, I still expect bond yields to move much higher, and the increase in nominal yields will probably hurt gold appeal through the real yield channel.
With the FOMC out of the way, institutional gold traders could trigger a sell-off in earnest on the expectation of solid US recovery, which could eventually shift 10-year yields above 2.25 %, But I think bullion bears will be less inclined to go on the offensive until US yields start to pick up again and break new higher ground.