Summary:
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Dollar declined against the euro the most since January 11, US stocks surged as Fed kept rates unchanged
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The Fed pointed to ‘patience’ in further moves and expressed its readiness to adjust the balance sheet reduction
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China’s manufacturing PMI ticked up in January staying in a contraction territory though
End or pause?
The Federal Reserve kept interest rates unchanged during its first meeting this year meeting economists’ expectations. However, the offered message was undoubtedly dovish casting a shadow on the further tightening process. First of all, the central bank admitted that it would be patient on future moves and it also expressed some readiness to adjust the balance sheet run-off in the light of economic and financial developments. In fact, Jerome Powell reiterated that all would depend on data when asked if the Fed had already ended or just made a pause in hiking rates. The bank’s communique said that it would continue to unwind the balance sheet by forgoing reinvestment of up to $50 billion in maturing securities each month. However, Powell added that the normalization process would be sooner and with the larger balance sheet than previously thought. It sent to markets a clear message that the Fed was far away from trimming its portfolio even nearby the pre-crisis levels. Asked repeatedly about the balance sheet normalization process Powell informed that this tool would not be actively used in conducting monetary policy and the ultimate size of the balance sheet would be determined by demand for reserves plus a buffer. Moreover, the bank is now evaluating the balance sheet plan and it would be finalizing them at coming meetings. When describing the global economic outlook Fed Chairman said that “we have seen cross-currents and conflicting signals.” He suggested that recent developments warranted patience in pursuing further rate hikes. As a result, the bank decided to get rid of a phrase saying that the balance of risks was “roughly balanced”. At the same time, the statement said that economic activity was solid (a slight downgrade from “strong” previously) which seems to be contrary to the presented “patient” stance regarding further gradual rate hikes.
Market reaction
Market-based rate hike expectations dwindled following the decision and now the FFF market assigns 10% to a ‘cut’ this year. Despite the clearly dovish message we stick to the view that the Fed has yet to terminate its monetary tightening cycle, however, the outlook for further rates has dimmed undoubtedly. While the Fed may still deliver one rate hike this year, we expect that first rate cuts might occur in the second half of 2020 when economic growth faced more headwinds. Either way, we are already very close to the end of monetary tightening, and this seems to be the major message sent from the Federal Reserve - a blow to the greenback. In the aftermath of the meeting the US dollar tanked while the US stock market shot up with the NASDAQ (US100) rising more than 2%. In the morning the EURUSD is trading in the vicinity of 1.15, well above the levels seen prior to the Fed’s decision. The US 10Y yield is hovering at 2.677%, down from 2.73% before the Fed’s rate verdict. The fall could have been more driven by fears about the economic growth outlook rather than the Fed’s statement that the balance sheet normalization process will continue.
Technically the EURUSD failed to break its local resistance at around 1.1490 immediately after the decision. However, the US dollar kept falling during Asian hours trading pushing the pair above this mark. From this point of view we think the euro demand could be sufficient to push the pair toward 1.1550 before some profit-taking occurs. Overall, we stick to our bearish long-term call on the dollar. Source: xStation5
Chinese PMI
During Asian hours trading we got some data from Japan and China. The most important release seems to be official Chinese PMI readings for January. The gauge for manufacturing came in at 49.5 beating slightly expectations and marking a tiny improvement from 49.4 seen in December. In turn, non-manufacturing PMI jumped to 55.7 from 53.8 while the consensus had pointed to no change. As far as Chinese manufacturing PMI is concerned January brought the second straight month when the sector contracted. Admittedly the data did not deteriorate, it added to concerns about the stuttering Chinese demand which was already reflected in the trade data for 2018. Note that the new orders subindex fell to 49.6 from 49.7 suggesting no improvement when the new year kicks off. Admittedly export orders ticked up to 46.9 from 46.6, however, they stayed deep into contraction. Chinese indices have traded higher with the Hang Seng (CHNComp) rising 1.3% at the time of writing, but the move has been mostly driven by the Fed.
The Hang Seng is cracking the important resistance nevertheless more obstacles still lie ahead. Source: xStation5
In the other news:
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Japanese industrial output fell 0.1% MoM in December beating the dismal consensus at a 0.5% MoM decline
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S&P upgraded New Zealand’s credit outlook to positive from stable citing expected budget surpluses in coming years which could allow to reduce the debt
