Trader's Thoughts - US Fed strikes more dovish tone than expected

The macro matters for markets

There are two things important to financial markets currently: the outlook for global growth and the state of financial conditions. That is: what are economic fundamentals showing, and how are central bankers responding to those fundamentals? At its core, the market rout in the last quarter of 2018 was about the interplay of these two concerns. Global growth was apparently slowing, unaided by the trade-war and a seemingly cyclical slow-down in the Chinese economy, while monetary policy was tightening, sucking liquidity out of financial markets. It was believed that a deterioration in the global economy was upon us (it may well still be) and those responsible for ensuring this does not eventuate were deaf to the cries of market participants.

The links between the fundamentals and the themes

This is the reason why a headline about a weaker Europe, or an escalation in the trade-war, or a story about the US Fed sticking to rate hikes or its quantitative tightening program, hurt the bulls so-much. The global economy can’t prosper without at least signs of solid growth, or the necessary support from monetary authorities to at the very least keep the global economy on life support. It shouldn’t come as a surprise necessarily for anyone whose sat trading in markets at any stage over the last decade. Even when times were nasty, like say during the turmoil at stages of 2015 and 2016, the notion that cheap money could at least support asset prices kept the now decade long bull market running.

US Fed announces itself as “patient”

Why this commentary is relevant this morning is the US Federal Reserve concluded its 2-day meeting and has handed to markets the dovishness for which they were waiting. The Fed in their accompanying statement has implored that because of recent developments in global economic and financial conditions, they “will be patient” in adjusting monetary policy. And better yet – this is what market-bulls were hoping they’d hear – the Fed explicitly stated it’s open to adjusting the timeline for its “balance sheet normalization”. Put simply, this says that in response to the recent chaos in asset markets, the US Fed will step away from its aspirations to normalize monetary policy and spend some time reviewing new developments in the global economy and financial markets.

Risk-on as Fed gets dovish

Traders have been tentatively pricing in this change in tone from the US Fed for the last month, hence the recovery rally witnessed in global equities throughout January. What last night’s events amount to now is the explicit assurance, written in black-and-white, that the Fed will tone-down its hawkishness. Risk is “on” consequently and financial markets are adjusting prices to accommodate for the new “patient” US Fed. Wall Street is rallying, with the S&P 500 up 1.7% at time of writing, the USD is down as rate hikes are priced out and bond yields fall, pushing up gold prices. Credit markets have continued to rally, extending its recent recovery. And the Australian Dollar is much higher, up over 1% post-release.

An overall positive day

Though definitely the most significant, the Fed meeting wasn’t the only story moving markets. Overall, the news lined up in the favour of the bulls. Apple’s results in afterhours trade on Wednesday morning took one risk off the table and showed a set of numbers below that of previous earning’s reports, but above that priced in to financial markets. A lift in oil prices too supported sentiment, boosting very slightly inflation expectations and relieving pressure on credit markets, after US crude inventory data showed a greater than expected drawdown and traders priced in the impacts of sanctions on Venezuela. Finally, markets welcomed a solid set of unemployment figures in last night’s ADP Non-Farm Payrolls release.

Data for local traders, too

Not to be left behind by rapid international developments, the Australian economy gained insight into the domestic outlook yesterday. CPI data was released, and surprised modestly to the upside, printing at 1.8%, against a 1.7% forecast. Markets took well to the data, immediately resulting in a 0.4% leap in the Australian Dollar, with interest rate traders reducing the implied probability of a rate cut from the RBA this year to somewhere between 35% – 40%. It was a better outcome, to be sure, and one that will keep at bay temporarily the doomsayers suggesting the Australian economy is in a deteriorating condition. However, it is also true that inflation remains below the RBA’s target band, and trending lower, meaning rate cuts remain the market’s bias.

How will a range trading ASX respond?

Against a busy macroeconomic backdrop, and further risk events to come before the week concludes, SPI Futures are indicating a 17-point jump at the open for the ASX 200. It was a nominally positive day for the ASX yesterday, supported primarily by a continued rally in materials stocks in response to higher iron ore prices. Volume was high as market conditions return to normal after the January holiday period, but breadth was low, with less than half the market higher for the day. Noteworthy too, is that the ASX 200 once again failed to break through its 200-day EMA and remains stuck in a trading range. The Fed’s developments this morning will support sentiment today, but perhaps it will need to be positive noises from US-China trade talks to spark the next move higher.