Was the Fed a case of Much Ado About Nothing?

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by Shaun Richards

We have become used to central banking being a bit dull, certainly compared to March last year. They essentially opened the monetary taps and have spent the intervening period not doing much. We have had some fiddling at the edges and a lot of open mouth operations, but last night the stakes were higher because of the pace of the recovery in the US economy. If we move to the effect we can see that markets made an immediate response.

After FED meetings, gold fell down significantly in the last Newyork session, from $1860/oz to $1800/oz, then went up back to $1820/oz ( @fxstreet)

So Gold was hit immediately and the futures contract is at US $1810 this morning meaning that $50 was knocked off its price. So it has been a bad 24 hours for Gold bugs and places were it is held such as India. This gives us our first hint of some news about interest-rates.

Hollar Dollar

Investing.com gives us the picture.

At 3:15 AM ET (0755 GMT), the Dollar Index, which tracks the greenback against a basket of six other currencies, was traded 0.2% higher at 91.418, after surging nearly 1% overnight, its biggest rise since March of last year.

The rally meant that we have seen some big figure changes with the Euro pushed below 1.20 and the UK Pound £ pushed below $1.40. They should not matter but often do. Also there was some relief for the Bank of Japan as the Yen weakened to 110.60 as it continued a weaker run for the Yen since the days it ended up being pinned around 104.

Bond Markets

Having established a theme of financial markets responding to something about interest-rates we now move to one which gives a qualified response. What I mean by that is yes we get some confirmation from a 0.07% rise to 1.56% for the US ten-year yield but it is not a large move. Also bond yields had been falling for the last couple of weeks so net we are still lower.

The Federal Reserve

The initial statement only gave is a couple of hints.

 Amid this progress and strong policy support, indicators of economic activity and employment have strengthened.

So some confirmation of an improvement and we also got the beginnings of covering their backside on inflation via the use of “largely”

Inflation has risen, largely reflecting transitory factors

But neither of those explain the market response. Nor does the interest-rate change which was announced.

The Board of Governors of the Federal Reserve System voted unanimously to set the interest rate paid on required and excess reserve balances at 0.15 percent, effective June 17, 2021.

The 0.05% move was also applied to the troubled reverse repo market which went from 0% to 0.05% and we see why from this.

53 COUNTERPARTIES TAKE $520.9 BLN AT FED’S FIXED-RATE REVERSE REPO. ( @FinancialJuice)

We have looked at this several times before where the monetary push from the Federal Reserve has been added to by the fiscal stimulus and the cheques in particular leaving the banking system awash with cash. The pressure has been such there has been a danger of negative interest-rates spreading ( we have seen some in US Treasury Bills). I know it is an irony but the Fed is now acting to stop further falls in interest-rates. Or as Stevie V put it.

Money talks, mmm, mmm, money talks
Dirty cash I want you, dirty cash I need you, ooh

The US Treasury has been asleep here as it could have helped by issuing some more bonds, it is not as if it will not have deficits to finance.

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Projections

More meat came here.

However, the jolt came when new projections saw 11 of 18 central bank policy makers plan for two interest rate increases of 25 basis points in 2023, a year earlier than expected, and a sharp change from the previous meeting when none of these officials were looking for hikes during that year.  ( Investing.com)

Such was the shift that the projection had a 0.6% expectation for interest-rates in 2023 or two 0.25% hikes from the present 0.1%. This led to this perception.

“With the world’s so-called ‘smartest market’ expecting a quicker and more aggressive liftoff in interest rates, the fallout from this Fed meeting could continue to drive all markets in the days and weeks to come,” said Matthew Weller, Global Head of Market Research at GAIN Capital. ( Investing.com)

I have no idea how he could consider that to be aggressive but each to their own. As to the meaning of the shift well I well leave that to Chair Powell.

FED Chair Powell: Not Appropriate To Lay Out Numbers That Mean Substantial Further Progress

– Dots Are Not A Great Forecaster Of Future Rate Moves

– Didn’t Discuss If Liftoff Appropriate In Particular Year  (@LiveSquawk )

This is a bit awkward because having sent a signal about higher interest-rates you then say that it does not mean much. Ironically he is of course correct with the statement that central bankers are not great forecasters of future rate moves, and he has thus just torpedoed the “Forward Guidance” claims that have been pressed over the past few years. It gets more awkward as we note they have predicted a “Liftoff” in 2023 but didn’t discuss it. What did they discuss then?

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If we return to the dot plot then we see this from Chair Powell back in March 2019.

Each participant’s dots reflect that participant’s view of the policy that would be appropriate in the scenario that he or she sees as most likely.

That could be from Sir Humphrey Appleby in Yes Minister.

Taper Talk 

Essentially it remains that because there is no change.

 In addition, the Federal Reserve will continue to increase its holdings of Treasury securities by at least $80 billion per month and of agency mortgage‑backed securities by at least $40 billion per month until substantial further progress has been made toward the Committee’s maximum employment and price stability goals.

Comment

In some ways this echoes the much ado about nothing line from William Shakespeare. The Fed has sent a signal with its forecasts but it is hard not to smile at reports it is being hawkish, especially when CPI inflation is at 5%. Also raising interest-rates in 2023 is an inversion of monetary policy leads and lags with inflation higher now. If it is transitory then why bother? Indeed I could go further because in its forecasts is the assumption that the “normal” level of interest-rates is now 2.5%, does anyone actually believe that? None of this deals with house price rises in double-digits.

The Tapering of QE is an issue where some will keep talking about it and claim to be right should it happen forgetting the failed lottery tickets they previously bought. But my view is that the central banks are all hoping someone else will move first. I know that the Bank of Canada has acted but having bought around 40% of the market in short order it soon would have been out of road anyway.

So we are left with markets and if they have pushed the US Dollar upwards and it persists then they may have achieved something. Although did they intend to? Also we have the nuance which is do we have a clear cause and effect or were markets waiting for a trigger and without the Fed something else would have come along?

Also we saw a bit of insurance taken out against the future.

The Federal Reserve on Wednesday announced the extension of its temporary U.S. dollar liquidity swap lines with nine central banks through December 31, 2021

So they can use the word temporary…….

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