Words over actions from the US Fed

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From one angle, it was a big change, pledging to keep rates low for two years, rather than the previous pledge which translated to around three months. But for markets, it was not a big leap, given that interest rate markets were not far off pricing steady rates for the coming two years anyway.  The Fed’s language on the economy has changed substantially. It now acknowledges that “economic growth so far this year has been considerably lower than the committee had expected”. 

Furthermore, it has changed its outlook, from expecting the pace of recovery to pick up over coming quarter, to expecting “a somewhat slower pace of recovery over coming quarters” than it did at the time of the previous meeting. By using words over actions, the Fed has chosen to keep some of its limited arsenal in reserve. The Fed, more than any other central bank, is running low on policy options and the reaction on stocks especially reflects the fact that markets are starting to sense that.

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Commentary

Market verdict eventually positive on the Fed decision.  The initial response on stock markets to the Fed meeting result was disappointment, with stocks especially having become hopeful of a fresh round of quantitative easing from the US central bank.  After the initial dip lower, stocks ended the US session in positive territory, with the better tone having been carried through to the Asia session.  The Aussie has also pulled away from parity, with the greenback around 0.7% softer since the announcement (using dollar index).

Bank of England presents outdated inflation report.  The Bank of England is due to present its latest Inflation Report today, but the publication, which was put to bed a week ago, could look a little dated given the latest developments in global financial markets. It is likely to further downgrade its growth projections for this year and next, not only on the disappointing data seen recently (0.2% growth in Q2), but also on the back of the weaker global picture.  However, the Bank’s ability to respond to the weaker outlook remains constrained by the continued strength of headline inflation, which still is likely to move higher over the coming months, principally from higher domestic utility prices.  A conditionally more dovish report should be seen.

China trade data surges ahead once again.  The July trade balance of USD 31.5bln was the highest for over two years, with exports surging by 20.4% YoY.  Imports were growing by           23%, which is still an encouraging for those economies reliant on the continued buoyancy of the Chinese economy.

SNB and BOJ left high and dry. After the policy measures of last week to curb the strength of their currencies, both Switzerland and Japan can only stand and stare as the relentless rise continues. The Swiss franc is now nearly 3% firmer vs. the euro compared to where it stood just before the SNB’s easing of policy on Wednesday of last week. Meanwhile, the yen is back right to its pre-intervention levels vs. the dollar.  The Swiss move was understandable for two reasons. Firstly, the SNB did not come out and sell the franc directly in the market, partly owing to the reduced resilience of its balance sheet vs. the last time it intervened. Secondly, the fact that Switzerland is a picture of fiscal austerity compared with Japan and most other major currencies has caused it to be pretty much singled out in the safe-haven stakes. The only other real competitor is gold, which naturally is dollar-based so carries with it its own risks.  The issue for both currencies is that they are pushing against global forces and right now, as well as the safe-haven bid from sovereign risk concerns; there is also the more general risk aversion trend from the global growth slowdown. This is seeing a lot of remaining carry trades closed out, adding further upward pressure on both currencies. Until the dust settles after the current sell-off both are likely to sit back, but further intervention remains a risk. Unfortunately for both, they are likely to be alone as most other major economies do not want to see their currencies appreciate at this point in time via coordinated intervention.

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