The Kremlinologists turned out to be right, and the Federal Reserve left its “considerable time” language in its statement to assure the markets that it would be around for a while longer with rock bottom rates. It’s the divergent (to a point) reaction out of the markets themselves that is interesting to parse, and will be key to watch in coming weeks and months. The action in the stock market was to suggest the entire exercise was a snooze-fest, with stocks ending marginally higher (yes, the Dow at a new record) but not too far from where the major averages were trading just before the news. Which is to say the equity market, always the most optimistic of U.S. markets, has it in mind that low rates stay for now, and until “now” is “then,” it’s time to party.
Bond markets, inflation-protected securities and the currency markets saw things differently, and it’s those markets that may be more instructive to watch as the days and months go on and on. The five-year TIPS note saw its yield break above zero for the first time in ages, a sign that investors are starting to worry more about inflation, or higher Fed rates, which is interesting as consumer price data showed year-over-year inflation fall to a 1.7 percent rate earlier in the day. The dollar put together another strong rally, meanwhile, with the dollar index hitting highs not seen in 14 months and big rises against its main companions, the euro and the yen. And this is where the dot matrix comes in.
The dots, of course, are not an array of Janet Yellen’s prowess (or lack thereof) at the firing range, but the expectation from Fed officials on where they see rates in coming years. With 2017′s dots all suggesting rates at greater than 3 percent – and closer to 4 percent – the currency market has taken the hawkish outlook here, as Jens Nordvig, strategist at Nomura, said in an email to Reuters. There were two dissenters – the usual suspects, Charles Plosser of Philly and Richard Fisher of Dallas – who were not thrilled to see the statement so dovish, and so Nordvig takes all this and says that this should be “enough to sustain USD uptrend vs G10″ currencies, so, against the yen, euro, Swiss franc, pound and all the others.
He does warn, however, that the kind of uncertainty that would drive significant outperformance against the emerging markets currencies is not yet present, given rates are going to be low for some time, so that firm is closing some call options outstanding against the peso and ringgit while sticking with long bets against the yen and euro. “It will also soon be time to ask new questions on the Dollar. What will be the pace of tightening the US economy can cope with? What is the strength of capital flows into the US? Answers to these questions will determine whether the relatively sharp Dollar move in the last 2-3 months can be extrapolated over the next 3-6 months,” he wrote in late commentary Wednesday. There’s also the possibility, of course, that markets overreacted to the Fed – another soft jobs report would undo a lot of the recent gains in the dollar, or even a couple of other second-tier indicators reinforcing the notion that the outlook from individual Fed members on rates is just that – an outlook – and as a result cannot be trusted insomuch as the data will tell them what to do, dots and dollar strength and models be damned.
The dollar strength may be temporarily interrupted as investors await the overnight results of the Scottish referendum to decide whether the movie Braveheart was all for nothing (I think that’s what the vote is for, anyway). Varying polls have swung the pound wildly in recent days, but the latest set of polling seems to suggest a modest win for those who want to maintain the current situation, where Scotland remains the northern part of the United Kingdom rather than strike out on its own and force the English to build a 700-foot wall to keep them out (again, not sure if that question is on the ballot or not).