A Dovish Fed Lifts Stocks And Hits The US Dollar

Originally published by AxiTrader h2 Market Summary/h2

Dovish FOMC minutes and a gradualist approach to trimming the Fed’s $4.5 trillion balance sheet helped lift the S&P 500 to a record close this morning. At 2404.39 the S&P is up 0.25% after a 6 point gain. The Dow Jones Industrial Average rose 0.36% to 21,012 and the Nasdaq 100 was 0.4% higher at 6163.

That’s helped lift the SPI 10 points this morning but it also served to undermine the US dollar a little with the US Dollar Index down 0.3%.

That move has been good enough to get the euro back above 1.12, put the USD/JPY back under pressure and allow the Aussie back above 75 cents as I write. Not huge moves but the Fed highlighted the weak data as a potential handbrake on rate hikes which is important to forex traders.

Oil of course has been of great interest again overnight as we await the decision at OPEC’s meeting in Vienna tonight. IT’s widely anticipated to extend production cuts for 9 months but oil is a little lower this morning at $51.27 in WTI terms. That’s despite a big draw in gasoline inventories.

Gold is higher, while copper and base metals seem to have recovered from yesterday’s shock of Moody’s Chinese downgrade

• S&P 500 +6 (0.25%) 2404 (7.39Sydney - change since previous day)
• Dow +74 (0.36%) 21012
• Nasdaq +24 (0.4%) 6,163
• SPI 200 +12 (0.20%) 5,786
• AUDUSD 0.7501 (0.36%)
• Gold $1258 (-0.60%)
• WTI Oil $51.30 (+0.33%)

• The Fed minutes were not as hawkish as I expected with participants noting they needed further evidence in the data to prove that the first quarter slowdown was indeed transitory. Yes they still say that it would be appropriate to soon lift rates again. But it's dependent and the minutes reflect strongly that Fed staffers and FOMC members did see the slow down as “transitory” – the word appears ten times in the minutes.

• But the comment which adds the dovish tone to the minutes is that “Members generally judged that it would be prudent to await additional evidence indicating that the recent slowing in the pace of economic activity had been transitory before taking another step in removing accommodation”. Further moves would be judged against objectives of “of maximum employment and 2 percent inflation,” the minutes said.

• That suggests the June hike may not be the lock that markets think. That’s especially the case with the Citibank economic surprise index languishing at -38.8 at the moment. But given this mandate, and given the release of non-farm payrolls next week it’s too early to write off a hike yet. Indeed the CME FedWatch tool still estimates an 83% chance of such a hike this morning. Perhaps it’s that next hike which is now less certain – market pricing seems to reflect that.

• That particularly the case given the minutes also reflected that the Fed appears to have come to a consensus on the reduction of its balance sheet this year. The minutes reflect that the operational actions will be a gradual increase in the run off of the balance sheet. What’s really interesting about the language around this – and I sense the inclusion of a behavioural economist here – is that the Fed is at pains to not say the balance sheet will run down in order, I think, not to spook the bond language. They have gone so far as to almost torture the English language to do this.

• For example, the minutes say (my emphasis), “The staff provided a briefing that summarised a possible operational approach to reducing the System's securities holdings in a gradual and predictable manner. Under the proposed approach, the Committee would announce a set of gradually increasing caps, or limits, on the dollar amounts of Treasury and agency securities that would be allowed to run off each month, and only the amounts of securities repayments that exceeded the caps would be reinvested each month. As the caps increased, reinvestments would decline, and the monthly reductions in the Federal Reserve's securities holdings would become larger. The caps would initially be set at low levels and then be raised every three months, over a set period of time, to their fully phased-in levels. The final values of the caps would then be maintained until the size of the balance sheet was normalised.” Ugh, ugh, ugh. Such torture.

• Moody’s decided to act on the concern many have about Chinese dabt and downgraded the rating of China yesterday. The ratings agency dropped China to A1 wth a stable outlook and while the timing of the move was a surprise the shock was actually in what they said about growth which they expect to fall to 5% in coming years. That of course is a natural consequence of the maturation process of the Chinese economy. But it’s a big number to put out there when China is aiming at and running above 6.5% right now.

• China’s finance ministry hit back saying “Moody’s views that China’s non-financial debt will rise rapidly and the government would continue to maintain growth via stimulus measures are exaggerating difficulties facing the Chinese economy, and underestimating the Chinese government’s ability to deepen supply-side structural reform and appropriately expand aggregate demand”.

• The ECB confirmed my thinking last night that it is where the Fed was a couple or a few years ago. The heavy hitting triumvirate of Mario Draghi, ECB vice-president Vitor Constancioa, and chief economist Peter Praet all acknowledged that growth had picked up but stressed it’s inflation they are worried about. The key comment was from Constancio who said, “I think that when we look at the history of monetary policy in Europe and outside, we have to be cautious about the premature withdrawal of stimulus, and if anything, it's preferable to err in the other direction”. SO we’ll hear changed language soon from the ECB about growth, and perhaps a continued taper. But rates are likely to stay where they are for a while it seems.

• Even as iron ore collapsed yesterday the ASX managed to eke out a 9 point, 0.15%, gain to close at 5,768. That the index managed to stay in the black on a day that miners came under intense pressure and finanicals were still struggling was actually a very solid performance for the market. Key to this was the rotation to the industrial sector which was the standout gainer on the day.

• SPI traders have marked prices up another 7 points overnight after the unspectacular but still solid move in US stocks. It remains the case that the hysical market has resistance around the 5,800/10 region but when I look at the SPI there are two competing outlooks as you can see in the chart below. Either one suggests however that the SPI is mid range here at 5784 between the recent low around 5680 and the downtrend line at 5870.

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• Yesterday’s construction data was a little concerning. Tapas Strickland, and economist at the NAB, said that the big miss in the data of -0.7% versus the expected -0.1% will subtract 0.2% from the NAB’s GDP estimate which increases the chances of a very small growth number and maybe even a negative print. Construction work done is the first of a number of partials that feed into the release of Australia’s GDP release next Wednesday. As a result expectations of what growth number we’ll see will be continually adjusted as the data is released. But that is not to underplay the significance of this data because the continuation of the building boom is a cornerstone of the RBA’s ebullient forecast of Australian growth. So if that’s ending early then the economy faces a sharper headwind than currently forecast.

• And that’s something that’s worrying Westpac chief economist Bill Evans. After the release of the Westpac-MI leading index of Australian growth yesterday showed a pretty solid 0.92% level above historical averages Evans sounded a warning. While he agrees with the “RBA’s current forecast of 3% growth through 2017” he noted that many of the drivers of strength were from offshore and as a result he said “We do have concerns for growth beyond 2017. Prospects for growth in 2018 look discouraging”.

• The key here is that like me Bill is worried about household spending. But in another release yesterday we saw that in contrast to the slightly depressed level of consumer confidence the NAB’s consumer anxiety index showed a fall in the survey last quarter to 55.9 from 58.7 at the end of 2016. According to Alan Oster, the NAB’s chief economist, all areas of the survey improved with labor market anxiety low or very low. That’s good news. If Australia can keep creating jobs then it will go a very long way to mitigating my concerns about the consumer outlook.