The assessment of how the US economy could recover coming out of the COVID-19 lockdown took a massive turn in the wake of the incredible rebound in the Non-farm Payrolls last week. The Federal Reserve monetary policy showed no change to rates (as expected) but as ever the devil is in the detail. The dollar remains under pressure and it seems to be risk positive again.
The Fed has not changed rates and made few changes to the FOMC statement. The main move that the Fed has made has been to show in the dot plots that rates are going to be staying at near zero through 2022. Additionally, the Fed has provided clarity on the increase its holdings of Treasuries which will be “at least at the current pace” over the “coming months” to support credit flow. This is an accommodative move and the risk trade likes it, however the same cannot be said of the dollar.
Changes to the FOMC Statement
Below we see the main changes to the statement. Although the financial conditions have “improved” there was a clarification of Treasury purchases too.
In a separate from the New York Fed (which runs the asset purchases) there was a specified that Treasury purchases on the SOMA (System Open Market Account) would increase at the current rate of around $80bn per month. Also increase the SOMA holdings of mortgage backed securities (MBS) at $40bn per month.
Due to the massive economic shock and emergency meetings of March, we have had to wait until the June meeting to have an updated set of economic projections. It must be said that these projections are also likely to change significantly in September and likely again in December as the Fed gets to factor in the recovery from lockdown but also the impact from potential second wave infections. However, at least we now find out the sort of ballpark spread of opinions on the committee.
The economic projections are clearly for a massive impact on GDP in 2020, by -6.5% (which is less than the OECD projection of -7.3% today).
Inflation is expected to remain well below the 2.0% mandated target through the projection period. This plays into the need for looser for longer monetary policy.
However, the dot plots show unanimous expectation of rates on hold during 2020 and 2021, whilst only two expect any increase in 2022. Rates will be on hold for a long while.
The Fed has given very little notice to the massive surprise on the payrolls data. A nod to “improved” financial conditions and then a pat on the back for monetary policy actions. Then broadly the statement is predictably downbeat (it is too early anyway for anything else, with no confirmation yet of any sustainable economic improvement). The dots say lower for longer rates, whilst the clarification of asset purchases to continue is accommodative.
Risk positive and dollar negative. It simply re-fuels the risk rally once more and further hits the outlook for the dollar. Although the dollar is stretched in its sell-off, this is a Fed decision that simply underlines the ongoing loose monetary policy and will play into the on-going dollar weakness in the coming months. It is interesting that Treasury yields initially popped higher before now moving lower. The Fed remains a massive buyer and this will continue to depress yields going forward (which will play into dollar weakness as the economy recovers). Equities like the move too.
- Treasury yields have been choppy, with the big moves coming at the longer end of the curve. The 10 year yield initially moved almost 3 basis points higher, but has now switched lower as the market has taken account of the asset purchases. The 10 year yield is now around 2 basis points lower from just prior to the announcement.
- EUR/USD has jumped strongly, but is now off its highs (c. +30 pips from prior to the annoucnement).
- GBP/USD has risen similarly by around +25 pips
- USD/JPY is c. -20 pips
- Gold jumped too but is also off its highs. Despite this, it is looking to hold above $1720/$1725 near term resistance
- S&P 500 has rallied c. +20 ticks (or c. 0.6%)