Markets Relieved By Fed’s Dovish Message… But For How Long?
Authored by Steve Englander via Standard Chartered,
The FOMC made few changes in the statement, but increased the ceiling for per counter-party overnight reverse repos from USD 30bn to USD 80bn.
The Fed’s economic projections did not include an increase in the fed funds target rate through 2023, although 7 of 18 participants did project a fed funds increase.
Dovish message a relief to asset markets, but for how long?
Investors were very focused on this FOMC meeting to see how projections and the policy stance would be affected by the March (and to some degree the December) fiscal stimulus. We had expected the Fed projections to show two 25bps hikes in 2023; we reckoned markets were anticipating one or somewhat less than one 2023 hike and the FOMC delivered none. This was a dovish surprise – the AUD, NZD, MXN, ZAR, NOK and BRL rallied more than 1% in the first hour after the announcement. Most major currencies appreciated within a range of 0.5% to 1.0%; 10Y UST yields, which had jumped 6bps in the run-up to the meeting, came back to their opening level of c.1.62%. Inflation breakevens moved somewhat higher, while real yields fell. The combined real and breakeven moves were supportive particularly for EM FX, but also G10 FX.
Fed Chair Powell repeated that there was no discomfort with the current level of yields.
Powell also made an effort to downplay the projections embedded in the dots, while emphasizing the importance of achieving (rather than forecasting) their inflation and unemployment targets under the Average Inflation Targeting framework.
For now, investors are absorbing a message that the Fed intends to be dovish until data indicates otherwise. This might change if we get a run of strong data in the coming weeks as the US economy reopens and fiscal stimulus hits.
In the short term, the fears that the market (as well as we) had of a Fed acknowledgment of a more optimistic landscape have dissipated. But we think these could be renewed if the pace of recovery suggests that full employment may be reached faster than shown in the dots.
We expect US yields to keep grinding higher, but we also think that any USD-positive effect will be temporary, with the yield increases not enough to offset long-term USD negatives from a wider current account deficit and increased debt.