FOMC goes even more dovish than markets had priced

All things progressing well in the global economy this could have easily been the meeting where we saw the continuation of Fed tightening. However, as the global cyclical downturn has taken hold, whilst protectionism has hit the prospects of the Eurozone and China, we have seen US data also beginning to slip. This resulted in a “patient” FOMC in January and the committee to hold rates today. Although the Fed was never expected to move on rates, the real news has been in the significantly dovish moves of the FOMC elsewhere, on potential futures rate moves, economic forecasts and its balance sheet reduction.

FOMC statement

In standing pat on interest rates, the slight changes to the FOMC statement are to downgrade growth, point to slower household spending and suggest that inflation remains low.

Here are the changes (image from ZeroHedge).

• Growth is now considered to have “slowed from the solid rate of Q4”, although this was no surprise.
• Household spending is seeing slower growth.
• Inflation also remains low.

FOMC dot plots

In the December dots, the FOMC was guiding for two hikes in 2019 (which in itself was down from a balance of three in September), with a further one hike in 2020. There were just two dots that were calling for no move at all this year. The longer run rate suggested 2.75% to 3.00%.

Below are the December dots:

And now the March dots:

Note how the March dots (below) showed massive capitulation of the herd on hikes in 2019, whilst they are claiming that perhaps one more may be seen in 2020. This is an incredible move lower on the dots and is a big surprise for a market that was largely looking for a likely average of one hike in 2019.

FOMC economic projections

Given that other central banks (ECB and Bank of England) have been busy slashing growth and inflation forecasts, it should come as little surprise that the Fed has cut back on its growth forecasts, and shaded lower on inflation.

• Growth – expectations for 2019 have been cut by -0.2% to 2.1%, whilst also shaving a tenth of a percent off 2020 growth to 1.9%.
• Inflation – on core PCE expectations are unchanged, with a mild cut to headline PCE by a tenth of a percent across the years.
• Unemployment – this was an interesting move as well, with an upward revision by +0.2% to 3.7% this year and 3.8% in 2020. This is a nod to the increase in the participation rate (drawn in by higher wages) where a larger the pool of labor increases the unemployment level.

Fed Balance sheet reduction

The balance sheet is currently around $4 trillion and consensus expecting the reduction to finish around $3.5tr to $3.6tr with the pace of reduction around $50bn per month. This would leave the reduction finished by the year end – something that the January FOMC minutes began to lay out. However, the March meeting has announced that the Fed balance sheet reduction program will end in September, sooner than expected. The Fed has also announced a slightly slower rate of balance sheet reduction on Treasurys from a cap of $30bn per month down to $15bn per month after May. This means that the balance sheet reduction will end up being in the range $3.6bn to $3.7bn and therefore larger than previously anticipated.

Market reaction

This has been an all over dovish range of decisions and this is seemingly a big capitulation from the committee (and way beyond where the market had been pricing). Treasury yields have fallen sharply and the dollar is under selling pressure. This is also positive for Wall Street in the initial reaction. Whilst this is likely to be a move lower on yields that persists, it will be interesting if this reaction higher on equities lasts. It is also interesting to see that according to CME Group FedWatch the probability of a rate CUT in 2019 has increased from 25% earlier today to now around 38%.

There have been some strong reactions across markets with several key levels broken. If the moves on EUR/USD and Gold can hold into the close these will be big outlook changers.

• US 10yr yield (-7 basis points) below 2.55% to its lowest since January 2018
• EUR/USD (+80 pips) more importantly too taking the market above $1.1420 which had been a key February high.     
• GBP/USD (+75 pips) and back above $1.3200 again (although Brexit remains key).
• USD/JPY (-75 pips) and more importantly below 110.75 support which puts the market under increased pressure.
• Gold (+$12) and above the long term pivot at $1310
• S&P 500 (+16 ticks)