As so often, it's not what they said but what they didn't say......

Thursday 29th October 2015

As so often, it's not what they said but what they didn't say......

Ref : General

Nobody was expecting too much out of the Fed's post-meeting statement yesterday, but in the event it's got plenty of people pretty excited. It's not as though there was anything in the bare text to provoke such a reaction, it's more about nuance and omission. ("Has it really come to this?" we hear you ask...)

Anyway, it's being taken as significant that the statement talked of the decision facing the Fed "at it's next meeting" rather than some indeterminate date in the future. More to the point, no mention was made of emerging market turmoil or global headwinds for the US economy, and that in itself was enough for many to infer that a December rate hike is very much back on the table. As defined by futures markets, the probability of such a move is about 48% this morning ..... last week that number got as low as 32%. It's worth adding one note of caution here : if the recent period of stability in emerging markets (comparatively speaking) is enough to encourage a more hawkish stance at the Fed, then presumably a major hiccup in those markets would be enough to turn them around again .... and who could ever be confident that such a possibility is ever very far away in such stressful times?

Still, if the decision is to be made on purely domestic issues, that would increase the chances of a December move. We'll be back to data watching, and particular attention will be paid to the two non-farm payroll reports between now and the Fed meeting. Much has been made of the weakness of the two most recent reports ..... all we'd say about that is that headline employment is at 5.1%, very close to what many believe is full "effective" employment. As an economy approaches that full employment level, it's only to be expected that payrolls data will slow. The next two numbers will have to be seriously bad (less than 100,000?) to stifle the enthusiasm of the more hawkish.

The immediate market reaction was as one might expect of an increased chance of a December rate hike, though it was not  particularly dramatic : lower equities, lower bond prices / higher yields, stronger US dollar. The strength of the dollar will not be welcomed by the Fed but it looks like they may take the view that it's a price they'll have to pay. It's hard to make a case against a stronger dollar .... remember the Fed meeting at which they MIGHT hike rates takes place on Dec 16th, less than 2 weeks after the ECB meeting which will probably see the announcement of further easing, so it's no great surprise to see US$ / Euro back down below 1.10. Even as things stand right now, the fact that a 10yr Treasury Note yields about 2.10% and it's German equivalent yields 0.43% tells us all we need to know about why capital flows are heading westward. People are talking about  US$ / Euro parity again, which is understandable but one should expect some pretty heavy traffic if that psychologically important benchmark is approached.

Of course there's another interpretation of yesterday's statement, one put forward by those sticking to the view that we'll be into 2016 before we see the first hike. Naturally, the Fed has to keep all its options open in case circumstances change. With expectations of a December move diminishing recently, all the Fed was doing yesterday was reminding us that it could happen if circumstances demanded it, and they were not saying that it's likely as things stand. Alerting us to the possibility (however remote) of a hike would mitigate against the shock factor should it actually happen, and could be seen as part of the Fed's tactic of Forward Guidance.

Regulars will be aware that we've been a bit sniffy at times about how the Fed has gone about its Forward Guidance .... occasionally it poses more problems than it solves. If it turns out that that's all yesterday's action was about, it would be a perfect case in point.