10 Takeaways From The FOMC

Top 10 Takeaways from January FOMC Statement

1. Fed Tapers by Another $10 billion, Starting February
2. $5 Billion Reduction each in MBS and Treasuries
3. Uber Dove Janet Yellen Supports Taper
4. Decision was Unanimous
5. Says Current Economic Activity “Picked Up” vs. “Expanding at Moderate Pace”
6. Sees Future Activity “Expanding at Moderate Pace” vs. “Pick Up”
7. Talks “Labor Market Indicators” vs. “Labor Market Conditions” – Further Improvement Seen
8. Household Spending & Business Investment “Advanced More Quickly”
9. Rollercoaster Ride in Emerging Markets Not a Big Problem for the US (lets see how long that lasts!)
10. Fisher, Kocherlakota, Pianalto and Plosser votes replace Bullard, Evans, George and Rosengren

The market’s erratic reaction to the January FOMC statement tells us that investors are worried about whether the central bank’s decision to unwind asset purchases during this period of heightened volatility is a wise one. The Federal Reserve’s decision sends a strong message to the market that they will not to be swayed by 2 weeks' worth of volatility in emerging markets or 1 month of weak job growth. In fact, the central bank described labor market indicators as improving and said current economic activity has picked up. The changes in their outlook are subtle but clear – they are more optimistic about future economic activity. For the first time since June 2011, the decision was unanimous, reflecting the impact of the new FOMC. Uber hawks Plosser and Fisher replaced uber doves Rosengren and George as voting members of the FOMC this year. Janet Yellen’s decision to vote in favor of tapering over the last 2 months also points to a smooth transition of leadership. Barring a massive sell-off in U.S. assets, she will continue reducing asset purchases and bring the central bank’s Quantitative Easing program to an end this year. Equity traders are obviously not happy with their decision because stocks have fallen 1%. The slide in U.S. yields and drop in USD/JPY reflects the market’s concern about the negative impact of Fed tapering on emerging market assets and risk appetite. The fear is that by tapering, the Fed will create more short-term pain for the financial markets but reacting to short term developments is exactly what the central bank hopes to avoid. The central bank reiterated its pledge to keep rates low well past the time when the unemployment rate reaches 6.5%. While Wednesday’s move by the Fed should be positive for the U.S. dollar, it seems that risk appetite continues to drive the movements in the foreign exchange market which means FX traders should keep their eyes on equities. The U.S.’ fourth quarter GDP report will be released Thursday and the pace of U.S. growth towards the end of the year will help investors decide whether the central bank’s action Wednesday was justified.

NZD Crashes Despite RBNZ Pledge to Raise Rates Soon

The New Zealand dollar fell sharply against the U.S. dollar Wednesday despite the Reserve Bank of New Zealand’s promise to begin raising interest rates soon. The RBNZ left interest rates unchanged at 2.5% and based on the price action of the NZD, some big investors must have been positioned for a rate hike in January. The only kiwi negative comment made by the Central Bank Governor Wheeler was his concern about the strong currency. He did not see the high NZD rate as sustainable in the long run. Having failed at every attempt to intervene, we don’t expect the RBNZ to do anything that would stand in the way of NZD strength. In fact, their plan to raise rates in the very near future is positive and not negative for the currency. Wheeler said the bank sees a need to return rates to normal levels and wants to start adjusting rates soon. The next RBNZ meeting is in March and we believe there is a 70% chance they will raise rates by 25bp at that time. Their recent increase in the LVR ratio helped to moderate housing market and the strong currency reduces inflationary pressures, which is why they could still afford to wait until April if necessary but judging from Wednesday’s comments, there’s a greater chance the move will happen in March. Therefore we view Wednesday’s sell-off in the New Zealand dollar as an opportunity to buy the currency at lower levels. The Australian and Canadian dollars continued to slide on the back of risk aversion. USD/CAD rose for the third consecutive trading day to a fresh 4-year high. Revisions to HSBC’s Chinese Manufacturing PMI report were scheduled forrelease Wednesday evening and a downward revision would accelerate the losses for commodity currencies.

EUR: Turkey Needs to Do More

The turmoil in emerging markets continues to wreck havoc on the broader financial markets. The Central Bank of Turkey took a big leap last night when they raised interest rates by 425bp but unfortunately their aggressive steps failed to stem the slide in the currency. The Turkish Lira has now erased all of its post rate hike gains. According to Turkey’s Prime Minister Erdogan, “alternative FX plans may be announced in few weeks.” At this stage, there’s no question that the central bank needs to come up with Plan B. Other central banks also took steps to halt the decline in their currencies. The South African Reserve Bank surprised the market Wednesday with a 50bp rate hike but traders shrugged off the news, driving the Rand to a fresh 5 year low against the U.S. dollar. The Russian Ruble, Hungarian Forint and Polish Zloty have also been hit hard by outflows with Russia’s currency falling to a record low. The Fed’s decision to taper asset purchases Wednesay will only add downside pressure on emerging market assets. In response, the central banks of Turkey, Russia, South Africa and other EM nations will need to do more to restore confidence and stabilize their currencies if they want to avoid further losses. German unemployment, consumer prices and Eurozone confidence numbers are scheduled for release Thursday. According to the PMIs, job creation eased in January so if the data surprises to the downside, the euro could extend lower.

GBP: BoE Carney Doesn’t Want to Raise Rates

Compared to all of the other major currencies, the British pound held up well against the U.S. dollar. There was no major U.K. data released Wednesday but Bank of England Governor Carney delivered a speech in Scotland where he expressed a lack of desire to raise interest rates. The level of unemployment is falling quickly but rather than talk about the improvements in the economy, Carney said, “a few quarters of U.K. growth aren’t enough. The recovery has some way to run before rates change” because he expects the “pace of consumption growth to slow” and inflation to remain benign due in part to the strong currency. The central bank also expects to provide further guidance next month and judging from Wednesday’s comments, they will make a point to guide down market expectations. We already know that 7% unemployment rate is a threshold and not a trigger for a rate hike so one of the few ways to achieve this goal would be to lower the threshold – a move that would undoubtedly be negative for sterling. The next move by the central bank will be a rate hike and given the overall cautiousness of the BoE, when they decide to tighten, it will be gradual.

USD/JPY Drops Below 102 on FOMC

Japanese Yen crosses continued to be hit by risk aversion. The sell-off in U.S. yields drove USD/JPY below 102 intraday. The 102 level is important but the key support for the currency pair is the December low near 101.60. It is very difficult for USD/JPY to rally without a rise in U.S. stocks or Treasury yields. Demand for the Japanese Yen will continue to be driven by the market’s appetite for risk. Retail sales numbers for the month of December are due and economists are looking for consumer spending growth to slow towards the end of the year. Signs of weakening demand could accelerate the losses in the Nikkei and in turn, drive USD/JPY lower. The crisis in emerging markets is likely to deteriorate further before it improves and for this reason, we expect further pressure on USD/JPY with a test of 101.60 likely.

Kathy Lien, Managing Director of FX Strategy for BK Asset Management.