From the perspective of an investor with a long equity position, Janet Yellen’s first swing at chairing an FOMC rate decision and the subsequent press conference went over like a lead balloon. While the release of the interest rate statement from the FOMC was a little more dovish than the previous communication, markets instead decided to key in on an increase of the median participant’s interest rate forecasts in the Summary of Economic Projections (SEP.) The statement itself altered the Fed’s previous forward guidance of assessing increasing interest rates once the unemployment rate hit 6.5%, and instead removed the quantitative measure altogether, replacing the 6.5% threshold with qualitative factors representing broader overall developments in the economy; with the US unemployment rate hovering around 6.7%, the current forward guidance was of little use for the Fed and market participants. Tempering the dovish altering of forward guidance, and the slightly lower revisions to GDP growth, FOMC members viewed the increasing at a faster clip than the last set of projections in December, a hawkish development that jolted financial markets. The median view of Fed officials saw interest rates at 1.0% by the end of 2015 (up from 0.75% in December) and 2.25% by 2016 (up from 1.75% in December.
The upward drift in rate expectations from the FOMC, along with Yellen stating in her press conference that the considerable period where rates would remain low after QE is wound down amounts to a period of about six months, caused a bout of USD buying, lifting the American unit against most other developed currencies, with the DXY rising 0.79% past the 80.00 handle. The market perception that QE would be wound down this year, amounts to rates starting to rise early-to-mid-2015, and is ahead of what most participants had expected to hear. Although during Yellen’s press conference the new chair of the FOMC urged investors not to focus on the SEP, and instead look at the language of the rate statement, equity investors weren’t buying what Yellen was selling, and instead decided to dump exposure to high-yield asset classes. The S&P managed to hold a bid after shedding 0.61%, Gold took a $30/ounce haircut from its highs on the day, while the yield on the 10-year US treasury spiked to 2.77%. USDCAD took another leg higher as the Loonie succumbed to additional selling pressure after interest rate hike expectations in the US were pushed forward; USDCAD popped through the 1.12 area with ease, then grinded higher as Yellen continued to speak. Although the move was a little violent considering only the slight change in expectation, our long-term view of USDCAD is still intact, with the view that economic activity in the US is likely to outpace growth in Canada, and that longer-term rates will continue to steepen on the long end of the curve and drive demand for the USD – to the detriment of the CAD.
The aftermath from the FOMC meeting continued during the overnight Asian session, with an exodus of capital from equities and other high-yield assets. Although fairly light from a news flow perspective, the Nikkei dropped 1.65% despite a weakening Japanese Yen, while the USDCNY exploded higher past the 6.2 mark, as the long Chinese Yuan trade continues to inflect pain on the leveraged carry-trade crowd.
The investment landscape in Europe is hardly fairing any better, with the major bourses well situated in negative territory as we get set for the North American handoff. Technical price action in EURUSD this morning continues to put pressure on the pair, taking another leg lower to drop below the 1.3800 mark, about a 150pt fall in the last two days. The drop today has violated the upward trend line that has been in place since early February, so if EURUSD holds south of 1.3800 today, there is a high probability we see the pair ebb lower to hone in on the 1.3700 handle, where the 50-day moving average lies along with the 61.8% fib retracement from the recent rally. Market participants naturally short EUR might want to think about taking advantage of the recent tumble in the common-currency, while still keeping some “dry-powder” to remain flexible should momentum cause EUR bulls to continue to cull some of their weaker positions.
Heading into the North American open, equity futures are displaying a weight to the tape, although the magnitude of the losses are subdued compared to yesterday’s price action. The DXY managed to build on its gains from yesterday overnight, with the USD basket up another 0.31% at 80.30. Commodities are struggling this morning, with Gold closing in on $1,322 per ounce (down another $8/ounce), Copper seeing 2.3% lopped from its value, with front-month Crude flirting with giving up the $100/barrel handle. The Philly Fed Manufacturing Index and Existing Home Sales are both due in a little over an hour, and while overshadowed by yesterday’s FOMC meeting, will still be the main focus of price action in financial markets today. Stronger than expected prints will confirm the hawkish interest rate bias telegraphed from the Fed yesterday and add to the momentum in the USD, while softer readings could temper some of the market pessimism surrounding monetary policy tightening, and help high-yielding assets claw back some of their recent losses.
Looking ahead to tomorrow, the main tier one economic events are CAD-centric, with USDCAD again set up to experience some volatility after CPI and Retail Sales figures are released. With sentiment having turned so drastically negative towards the Loonie after Poloz and Yellen this week, it is plausible to assume that anything on (or above expectations) would ease participants bearish view towards the Loonie, with any news that’s not dreadful likely to push the CAD in a positive manner. The main focus for Loonie traders will be the release of inflation statistics, which are forecast to show the headline reading sinking to 0.9% on a y/o/y basis in February. Part of the Loonie weakness exhibited on Tuesday was due to Poloz warning that the pop in inflation for January was likely to ebb lower in February, although the core reading is forecast to hold up a bit better and come in with a print of 1.1%. We would caution that a lower than expected inflation reading would accelerate the buying momentum in USDCAD, where anything north of 1.0% on the headline print would likely help the Loonie stem some of its losses from the last two days.
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