The Federal Reserve have given us a clear message that, barring some sort of collapse in sentiment in the next few weeks, March is good to go lift the fed funds rate. The narrative perhaps even throws weight to the camp that we could see hikes in the August, September and December meetings too.
We can see in the lead up to the FOMC statement (at 06:00 aedt) that other US economic data points had been trickling in, with a solid prints in the Employee Compensation Index (0.6%), the Chicago manufacturing PMI (65.7) and the ADP private payrolls report (234,000). Pending home sales came in as expected at 0.5% M/M in December. All were good numbers and should go some way to help mitigate poor reads in both tonight’s (02:00 aedt) US ISM manufacturing report and the non-farm payrolls (Saturday 03:00 aedt).
However, it was Janet Yellen’s last meeting at the helm of the Fed which is what the market was most interested in and the wash-up of the statement is that the market is now fully discounting a hike in the March meeting. US rates and bonds actually saw a reasonable move going into the FOMC statement, with some focus on the US Treasury Department looking to increase borrowing of long-term debt this quarter and some focus on the supply coming in next week’s $66 billion in United States 2-Year, 10-Year and 30-Year bond auctions.
However, the change in Fed’s language went some way to validate the earlier sell-down and we can look out the interest curve we can now see Eurodollar Futures initially pricing in 86 basis points (bp) of tightening from March 2018 through to March 2020, with this yield spread initially widening some 5bp on the day - a decent move by any standards. This has now dropped back a touch to 83bp.
Moves in the US Treasury market have also been widely noted, with most of the selling taking place in the 5- and 7-year part of the curve. Naturally, the US 10-year Treasury has caught the attention of most, with yields pushing into 2.75% (+4bp on the day) and the highest since April 2014, although, similar to what we saw in the interest rate markets, the bulls have waded in and the 10-year yield is back to 2.71%. So signs of a ‘sell the rumor, buy the fact’ scenario playing out here. It is certainly worthy of note that the yield advantage to hold Aussie 10-Year Treasurys over US 10-year Treasury traded down to 6bp, which was the lowest spread differential since mid-2000, but we now find this spread currently sitting at 9bp and it’s not surprising to see AUD 0.5% lower at $0.8058, although one could argue this is still a touch too high based on interest rate differentials.
Perhaps the key take away from the statement is that the Fed has altered the language that inflation remains “somewhat” below 2%, and we can now see that they see economic activity as “solid” and importantly that “Inflation on a 12‑month basis is expected to move up this year and to stabilize around the Committee's 2 percent objective over the medium term.” This is a more confident Fed and the narrative is more in-line with the markets own view, where we can see inflation expectations moving higher of late, although one could argue this has a lot to do with moves in energy. We also saw a slight upgrade to the Fed’s views on business investment and the overall statement seems to have been well suited to mark-to-market their views to the underlying dynamics in both the economy, as well as extremely loose financial conditions.
US equities found sellers on the statement, moving inversely to the initial move higher in bond yields, although it could have been worse had we seen ‘real’ (or inflation-adjusted) yields moving higher. However, as it is, the 10-year ‘real’ yield is actually slightly lower on the day. We can ultimately see the S&P 500 sitting unchanged at 2825, with Aussie S&P/ASX 200 Futures actually some 6 points higher in the night session. Our ASX 200 opening call therefore currently suggests an open at 6041, and we can see both the CBA and BHP ADR (American Depository Receipt) pretty much unchanged in US trade. Looking at the various sectors in the S&P 500, by way of a guide, and aside from a decent move higher in REITs, there is no clear guide for us today and understanding where the ASX 200 goes after the unwind is anyone’s guess. One could argue the positive flow seen yesterday could spill over into today’s trade, but there is little conviction here.
I had suggested yesterday that there was little in the lead to inspire buying and that view was incorrect. That said, the move higher in the ASX 200 was partially technical, with the bulls happy to defend the 6000 level, which has become a floor in the local market this year if one looks at the daily chart. The fundamental catalyst clearly being the slightly below consensus Q4 inflation print and we really have to look at the interest market here to understand the logic, as the market had gone into the inflation data feeling that an above-consensus print would be significant enough for the RBA to alter its stance to a more hawkish bias. We can see rate hike pricing for the May RBA meeting dropping from 5.5bp (or a 20% probability) of hikes priced to 2.5bp (or 10%) and for the December meeting we now have 21bp of hikes priced, down from 28bp. A decent re-pricing for what was a modest miss, and it’s no surprise, therefore, to see the ASX 200 stage a reasonable relief rally. It’s clear the equity market has voted and said Australia is not quite ready for rate hikes. The fact Trump stayed clear of trade issues was also a relief for markets around Asia too.
Looking around for broader leads we can also see a largely unchanged reads in commodities, with US Crude Oil sitting up 0.2%, with traders eyeing new statistics that US oil output has risen to the highest level since 1970, while also having to deal with a fairly messy weekly oil inventory report (gasoline inventories fell 1.98 million barrels, crude stocks +6.7 million and distillates -1.94 million). Gold Futures looks interesting, having traded to $1332 after the Fed statement and with traders buying back into US bonds we have seen the yellow metal rally 1% up to $1346. Copper is trading flat at $3.20 p/lb, with Iron ore also largely unchanged.