US curve adds interest
“The [US] dollar’s weaker and commodity prices are higher, and high-beta currencies like Aussie have done very well post the Fed. The other interesting mover has just been the curve shape in the US,” Ms Auld said, referring to the steepening curve in response to a view that the Fed has become neutral in its bias, causing yields at the short-end to fall.
“As a whole that doesn’t necessarily suggest the Fed should be on the cusp of capitulating.The median dot [forecast] is for two hikes this year. Our economists are saying if you can’t explain it through the fundamentals then you can only really explain it as a shift in the reaction function.”
Instead the Fed chairman told markets largely what they wanted to hear.
As RBC’s chief economist Tom Porcelli wrote, “we would have respected his view more if he just stated what most people seem to think anyway – the change in Fed tone of late had more to do with the equity market downturn than any concrete concern about the economic backdrop.”
When the Reserve Bank presents its updated forecasts next week (the January Fed meeting did not provide revised forecasts) the ongoing creation of jobsand slight improvement in inflationwill enablegovernor Philip Loweto keep his guidance credibly intact, with some concessions, Ms Auld said.
Narrative on course
“For the time being, that’s the narrative they’re going to go with.”
That being so, the Bank of Canada, Bank of England and European Central Bank have also sounded dovish in communications over the past couple of weeks.
“I do struggle to think the US is going to go into recession, growth will just slow to 1.5 to 2 per cent, as a worst case scenario,” Mark Bayley, head of institutional fixed income at FIIG Securities, said.
“That 2 per cent growth is actually fine for corporate credit, as long as companies can refinance existing maturities and the primary high-yield market has re-opened in January. My concern is that the equity markets are about to upset the apple cart. To me, the equity market valuations are still looking stretched and that’s where you will probably see the correction coming through.”
Wall Street responded enthusiastically to the Fed’s emphasis on a “patient” approach, the second time this year it has said as much. The Dow was up 1.8 per cent and the S&P 500 1.6 per cent. The reaction in Asia was less bullish with the Hang Seng and the Nikkei up more than 1 per cent and the Australian benchmark closing in the red.