Market Digests Fed, Greenback Consolidates, Antipodeans Tumble

The market has mostly interpreted the Fed’s action in line with
our thinking. 
Despite
the lowering of the long-run Fed funds rate, the shifting one of the three
hikes from 2019 into 2020, and recognizing that the weaker price impulses are
somewhat mysterious, the Fed clearly signaled its bias toward hiking rates one
more time this year and three next year. 
The long-term Fed funds rate
has trended lower. 
 In
March 2015, it was thought by the Fed’s dot plots to be near 3.75%.  A
year later it had been cut to 3.25%.  It briefly fell to 2.88% in
September 2016 before being lift last December to 3%. The cut now to 2.75% has
been generally signaled by Yellen (and other officials) suggesting the it may
be lower. 
One of the discrepancies
between the Fed and the markets is investors collectively see the long-run rate
as considerably lower than the Fed.
  Looking at the Fed Funds futures strip to give an
approximation suggest the market-based view of the long-term rate is closer to
1.75%.   The US 10-year breakeven is 1.86%.  The implication is that
the investors do not think the real Fed funds rate will be positive in this
cycle.  
The biggest surprise about
the Fed’s balance sheet signal was the seeming confusion of the media and
several times Yellen had to repeat herself. 
 The Fed had, we thought, made it
clear, that the balance sheet operations were not going to main tool of
monetary policy.  The operations would be put on automatic pilot and not
disrupted by short run vagaries in the economy. 
Some seemed critical of this
as being rigid, but if it were subject to regular FOMC decisions, the Fed would
have been criticized for not aiding market visibility and not being committed
to reducing its balance sheet.
  Some were critical that monetary policy did not
address the disparity of wealth and income in the US, but surely this is beyond
what monetary policy can do.  The Fed’s QE arguably prevented a larger or
longer downturn in the economy and this is often forgotten in such discussions.
 
The cost of a larger and
longer downturn falls primarily on the economic disadvantaged.
  It is true that homeowner and
equity owner did well as asset prices rose.  Rising asset prices were a
means to an end, the end being a stronger economic environment that created
more opportunities.  Although Yellen did not repeat it as forcefully as
the July FOMC minutes, but she acknowledged that the Fed was concerned about
financial conditions, and the elevated valuations of assets.  Doesn’t that
mean that so-called Greenspan put (Fed would provide accommodation in the case
of equity market decline) is less reliable, if it is there at all?  
Two other central banks have
meet today. 
 The
Bank of Japan left policy on hold.  A takeaway is that a new Board member
(Kataoka) argued that more stimulus is needed if the BOJ’s inflation is to be
reached.  This is important. Until now, Kuroda was criticized for doing
too much.  Now a new voice is calling for more not less.   To be sure
this does not mean that more stimulus will be delivered but for the first time,
there can be a debate within Kuroda’s framework and not simply old Shirakowa
acolytes pushing back against the considerably more activist monetary policy.
 
Norway’s central bank,
Norges Bank meet. 
 It
too left rates on hold, but increased its likely interest rate path for the
second consecutive meeting.  Norges Bank now sees the first hike toward
the middle of the next year.  If so, it will raise rates while the ECB’s
balance sheet continues to expand, and well before the ECB can raise rates.
 The krone is the strongest of the majors in the European morning, gaining
about 0.5% against the greenback and 0.4% against the euro. The euro held
NOK9.30 on the first try.  A break could see NOK9.22.  
The Antipodean currencies
are bearing the brunt of the greenback’s strength today, with the Australian
dollar pushing below $0.8000. 
 Trend line support, drawn from the mid-August low comes in
near $0.7940 today, which is also near the 61.8% retracement of that move
(~$0.7930).   A break would warn of the vulnerability of stops below
$0.7900.  
The New Zealand dollar has
come off half has much as the Aussie has, and perhaps is being support by the
latest polls that seem to suggest increased likelihood that the Nationals
continue to led the government.
   The Kiwi had previously under-performed the Aussie
and technically it appears poised for a recovery.  It is gaining against
the Aussie for the fifth consecutive session today and is at its best level in
a month.   The Aussie is approaching NZD1.0850, which corresponds to a
38.2% retracement of its Q3 advance.  The 50% retracement is a big figure
lower (~NZD1.0750).  
The US reports weekly
initial jobless claims. 
 This time series is being skewed by the powerful storms that
have hit in recent weeks.  The noise to signal ratio is high and most
likely will not have much impact.  The Philly Fed survey for September
will be interesting, but Yellen acknowledged yesterday what investors have
accepted.  The storms will reduce Q3 growth.  
Our back of the envelop
calculation suggested the hit could be as much as one percentage point.
  Given that the US economy was
growing above trend growth, it can fall back to it (which the Fed estimates the
long-run growth is 1.8%).   Leading economic indicators for August are
expected to rise 0.3%.  The monthly increase averaged 0.2% in 2016 and
0.4% thus far this year.  The diffusion, how many indicators improved and
how many deteriorated will likely confirm Yellen’s assessment that the
underlying economy remains strong.  
There are a few option
strikes that are worth noting.
  The $1.1950 level in the seems some distance now with
the euro ticking backup barely through the $1.1900 level, but a 1.7 bln euro
option struck there will be cut in NY later today. There is a strike at
GBP0.8840 for almost 450 mln euros also expires today. There are options struck
at NZD0.7300, with a notional value of NZD243 mln. 

More broadly the dollar is
largely consolidating yesterday’s post-Fed gains. 
Short-term market participants will not
have a lot of conviction of the near-term direction.  The dollar bears
will emphasize the lower long-term Fed funds rate and note that despite the
market pricing in a greater chance of a Fed hike in December, it remains
skeptical about hikes in 2018.  The bulls’ argument is mostly based, it
seems, on market positioning, though we argue that divergence is still a
powerful force, the political risks in Europe (Catalonia first, Italy next) may
reemerge as an important consideration, and the prospects of a tax cuts/reform
in the US may be under-appreciated.  


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