Source: Tradeview.com
"It is not unusual for markets to be irrational longer than you can stay liquid…"
Overview: Trump and his tariff tantrum seems to be trumping the central bank policies as paranoia takes hold of the financial markets. Positioning helped to drive risk off everywhere, leading equities lower while investors threw their weight to safe haven assets like US 10yr, German 10yr bonds and EUR/USD traders scratch their hair for direction, generating more dandruff to their keyboards.
So what happened with the FOMC? The FED (US Central Bank) came out with dots plotted close to indicating 4 rate hikes for 2018, but not with certainty. Therefore the market interpreted yesterday meeting as 3 rate hike for this year as a more realistic target. However there were upgrades to 2019 dots that implied increased from 2.25% to 3% with the long run terminal rate (where the FED is likely to stop hiking rates) moving towards 3%, above market expectations. There was also upgrade to economics forecasts (stronger GDP 2018 2.7% vs previous forecast of 2.5%) and higher inflation for 2019/20.
What did Powell say?
1st: He dampened these hawkish dots by saying it is not certain that FED will hike act what the dots say as it depends on data. This was then offset by the impression that the FED wants to hike in advance so that forecasted inflation does not become overheated, nor do they want inflation to be too subdued. What this means is that he is keeping his options (rather than committing to a more aggressive stance) open on his first ever meeting he has chaired since taking the job from Yellen.
However, the FED prefers to be proactive than reactive is key. It means the FED’s view towards normalisation is about preventing future inflationary problems in advance by employing rate hikes, even if the present inflation data isn’t well above 2%.
2nd: He did not care about the recent higher Dollar funding rate issues (Libor-OIS widened recently). The Fed is particularly clear that they will not change the pace of unwinding of QE and if there is any changes to the economic outlook, then the first action would be done from the interest rate changes, rather than from the QE side. This means that the Dollar excess liquidity should reduce as planned (see previous article: https://www.finduli.com/blog/keep-dancing-towards-the-exit) and be supportive to USD over the next few years.
What does it mean in practise?
Well it means 3 hikes this year and possibly another 3 hikes next year, which would bring the terminal rate to near 3% for the US base interest rate. Your mortgage is usually base rate + a bank spread. That means your floating mortgage would increase by around 1.25% to 1.5% in 2 years time. In addition, another several hundred billion dollars of QE will have been unwound (roughly $750bn) by end of 2019. These policies alongside higher US debt issuance should continue to build up pressure on US rates market, increasing cost of corporate and private debt. This is however justified on the grounds of strong US payroll and low unemployment figures. Trump tax cut policies also provide grounds for optimism until unless the trade war becomes a serious obstacle to growth and employment (which for now seems more like a political showcase).
Trade wars become the focus – for now:
It is obvious that the market reaction has been more on the tariffs slapped by Trump and potential escalation of trade war with China. However, the numbers of say $50bn is relatively small when compared to the actual GDP of US. What the market really is concerned about is the knock on effect and escalation. Due to this “fear” of increasing protectionism and higher future interest rates, we are seeing the stock market under bearish pressure (see 1st chart). Remember QE and excess cash helped create ASSET inflation (like shares and bonds), when the money is pulled out of the system, suddenly equities look lot less attractive vs risk free rate of the US fed rate.
EURUSD:
We previously mentioned (see article https://www.finduli.com/blog/keep-dancing-towards-the-exit) potential USD strength from any hawkish FED meeting. But as the hawkish meeting proved to be somewhat balanced by dovish Powell speech, the EURUSD bounced back up as positioning was heavy towards shorting EUR vs USD (Those who were short EURUSD probably covering their position). However, the EURUSD remains drifting sideways with technical starting to break towards bearish signals but not yet strong enough to conclude a strong direction until break out is confirmed. (see 2nd chart).
Source: Tradeview.com
References:
https://www.bloomberg.com/graphics/fomc-dot-plot/
https://www.c-span.org/video/?442824-1/federal-reserve-chair-jerome-powell-announces-interest-rate-hike
https://www.reuters.com/article/us-usa-trade-china/china-urges-u-s-away-from-brink-as-trump-picks-trade-weapons-idUSKBN1GY3E1
https://www.investopedia.com/terms/m/movingaverage.asp
https://www.google.co.uk/amp/s/amp.usatoday.com/amp/1045211001
https://www.zerohedge.com/news/2018-03-22/trump-suspends-tariffs-multiple-nations-not-china-until-may
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