Key Takeaways: Market Reactions to the outcome of the Fed’s December meeting
- The USD Index reached a new 14-year high.
- USDJPY reached 2016 highs of 117.86.
- SGD came close to beating it’s 2016 high.
- EURUSD broke below 1.05, a key level that has been held since March, prompting speculation of a lower EUR in 2017.
- US stocks lost the prior sessions’ gains to move lower from record highs, but confidence remains that further gains lie ahead.
- Despite a hawkish Fed, rated remain too low by historical standards to suppress stocks in any meaningful way. Fundamentals also remain supportive, and so we remain bullish on stocks in 2017.
Ahead of the recent US Federal Reserve meeting, the market had largely already priced in the initial rate hike and so there was a good chance of a US Dollar sell-off. Following the meeting, the US Dollar advanced across the board, with the US Dollar Index surging 1.69% in the hours following the announcement and reaching a fresh 14-year high. With little volatility around the meeting, it appears the Fed has been more hawkish than expected—FOMC members were previously expecting two rate hikes in 2017, and now we are potentially looking at three rate hikes next year.
Economic forecasts from the Fed and no mention of a ‘high’ US Dollar meant the USD was a binary bet across global markets. By the close of the meeting, there were positive signals for the Greenback, however the odds of a correction for the USD remain high moving into 2017. While we remain confident in the dollar overall next year, this correction will be vital before taking a stanch bullish approach.
For now, traders seem intent on maintaining the positive sentiment they’ve shown this December, making this one of the better Santa’s rallies of recent years.
There are four primary factors that have the potential to affect the impact of the meeting, and will continue to influence market sentiment as we move into 2017: 1) the rate hike; 2) the ‘dot plot’; 3) the press conference; and, 4) Fed projections.
1) The Rate Hike
The Federal Reserve announced that target federal funds rate would be hiked by 25 basis points, marking only the second time in 10 years that the Federal Reserve have raised rates.
With market expectations for a rate hike between 90 and 100%, it is arguable that it would have been irresponsible for the Fed not to have raised rates.
2) The ‘Dot Plot’
The ‘dot plot’ represents the Federal Reserve board of voting members’ views on the rate trajectory.
During the meeting, the ‘dot plot’ shifted higher across the board exhibiting a convergent view on the general direction that rates will take. The high low range remains very wide however. A higher and narrower spread of dots would have displayed greater confidence in the rate hike trajectory.
3) The Press Conference
During the press conference after the meeting, Federal Reserve Chairwoman Janet Yellen was cautiously upbeat on the economy and played down any impact the pending Trump administration may have on their forecasts and future actions.
4) The Fed Predictions
Projections for the economy have been adjusted modestly higher across the curve, as expected. Interestingly, the central tendency and range has narrowed slightly for Fed funds and GDP in 2017 and 2018.
Using median values, compared to September meeting forecasts there are several economic data points that have now been revised higher. For example, the Federal funds rate is now 1.4 in 2017, 2.1 in 2018, and 2.9 in 2019, compared to a September projection of 1.1, 1.9 and 2.6 respectively.
While revisions to GDP were modest, members had recently said they weren’t factoring in president Trump’s potential policy shifts, and so there will be changes as these will be factored in later.
Arguably the most important figure to the Fed is the Core PCE, which is their preferred inflation gauge. Somewhat surprisingly no revisions to this were made, as even if minor upward revisions had been made this would have resulted in even more gains for the US Dollar.
There have been signs of rising global inflation, and as this also has not been factored into the Fed’s forecasts it will be something to monitor in 2017 as revisions here will result in higher hike expectations.
Further hike expectations
Given that this recent rate rise by the Fed was expected and factored in, the markets focus is already on the next hike.
The CME FedWatch tool shows future markets are pricing in a 49.8% probability of a June hike to 75-100 bps. May and June are also contenders at 34.1% and 44.1% respectively, but these numbers will change daily as and when new economic data, commentary or White House policies arrive following Trump’s inauguration.
A second hike to 125-150 bps is favoured in September at 36.3%, and a third hike in favoured in December at 15.4%. However, when we consider the Fed only provided one of the four hikes suggested last year, a third hike is far from confirmed.
Matt Simpson is a Senior Market Analyst at ThinkMarkets.com