All eyes have now turned to the Fed
As pundits expect Jay will spread
The message that rates,
Until future dates,
Are fixed, unless lowered instead

Most market activity is muted this morning as traders and investors await the latest words of wisdom from Chairman Jay and his compadres. The key questions in the air are:

1. What will the Fed’s new forecasts describe?
2. What will the dot plot (remember that?) look like?
3. Will there be any change in current forward guidance?
4. Will there be any mention of yield curve control (YCC)?

Let’s quickly try to unpack these and see what they mean.

1. The Fed ordinarily updates its economic forecasts quarterly, but wisely, in my view, skipped March’s update given the incredible uncertainty that existed due to the beginnings of the Covid-19 impact. Three months later, the breadth of economic destruction has become clearer, but it will be interesting to learn their current views on the topic. For comparison, last week the ECB forecast a central scenario of Eurozone GDP as follows: 2020 -8.7%, 2021 +5.2%, 2022 +3.3%. The OECD forecast global GDP at -6.0% this year and US GDP at -7.3% this year assuming no second wave of infections. Those numbers fall to -7.6% and -8.5% respectively if there is a second wave of Covid infections. No matter how you slice it, 2020 is set to report negative GDP growth, but the question is, will the Fed demonstrate relative optimism or not?

2. The dot plot, as you may recall, was the biggest issue for a long time, as it was the Fed’s non-verbal way of offering forward guidance. The idea was that each FOMC member would offer his/her own views of the future level of rates and the median forecast was seen as a proxy of the Fed’s views. While it is abundantly clear that the view for 2020 will remain 0.00%, the real question is what the timeline anticipated by the FOMC will be as to when rates can start to rise again. It strikes me that while there will be some divergence, as always, we are likely to see only very gradual increases expressed, with a real possibility that 2021’s median will also be 0.00% and rates only beginning to rise in 2022. This begs the question…

3. How will they proffer their forward guidance? Current language is as follows: “The Committee expects to maintain this target (0.00%-0.25%) until it is confident that the economy has weathered recent events and is on track to achieve its maximum employment and price stability goals.” Current thoughts are they could become more specific with respect to the timeline, (e.g. saying rates would remain at current levels until the end of 2022) or with respect to data (e.g. until Unemployment is at 5.0% and Inflation is back to 2.0%). Of course, the lesson from Chairman Bernanke is that if they go the latter route, they can easily change the level as they see fit. But for now, the longer the timeline, the more confidence that would seem to be imparted. At least, that’s the theory.

4. Finally, there has been a great deal of discussion regarding YCC and whether the Fed will announce a program akin to the BOJ (10-year) or RBA (3-year) where they target a rate on a specific maturity of the Treasury curve. Most analysts, as well as Cleveland Fed President Mester, believe it is too early to make a pronouncement on this subject, but there are those who believe that despite the equity market’s recent frothiness, they may want to step harder on the gas pedal to make sure they keep up what little momentum seems to have started. To me, this is the biggest story of the afternoon, and the one with the opportunity for the most market impact. It is not fully priced in, by any means, and so would likely see a huge rally in both bonds and stocks as the dollar fell sharply if they were to announce a program like this. I like gold on this move as well.

So, plenty to look forward to this afternoon, which explains why market activity has been so limited overall so far today. Equity markets in Asia were barely changed, although in the past few hours we have seen European bourses start to decline from early modest gains. At this point the DAX (-0.8% and CAC (-0.6%) are fully representative of the entire Eurozone space. At the same time, US futures have turned mixed from earlier modest gains with Dow e-minis down 0.3% although NASAAQ futures are actually higher by a similar amount.

Bond markets are generally anticipating something from the Fed as the 10-year has rallied and yields declined a further 3bps which now takes the decline since Friday’s close to 10bps. Bunds and Gilts are both firmer as well, with modestly lower yields while the PIGS are mixed as Greek yields have tumbled 9bps while Spain (+3bps) and Portugal (+4.5bps) see rising yields instead.

And finally, the dollar is definitely on its back foot this morning. In fact, it is lower vs. the entire G10 bloc with Aussie and Kiwi leading the way with 0.5% gains. Right now, the Aussie story looks more technical than fundamental, as it approaches, but cannot really hold 0.70, its highest point in almost a year. But overall, what is interesting about this movement is that despite yesterday’s desultory equity performance and this morning’s modest one as well, the dollar is behaving in a risk-on manner. Something else is afoot, but I have not yet been able to suss it out. I will though!

In the EMG space, the dollar is lower against virtually all its counterparts with IDR as the major exception. The rupiah fell 0.65% last night, actually recouping larger earlier losses at the end of the session, after the central bank explained they would be capping any strength in an effort to help Indonesian exporters. On the plus side is a range of currencies from all three blocs, which is evidence of pure dollar weakness rather than specific positive currency stories.

On the data front, overnight we learned that Chinese PPI was weaker than expected, reflecting weakness in its export markets and not boding well for that elusive V-shaped recovery. We also saw horrific April French IP data (-34.2% Y/Y), but that was pretty much as expected. This morning we get the latest CPI data from the US (exp 0.3%, 1.3% ex food & energy), but inflation remains a secondary concern to the Fed for now. Rather, there is far more focus on the employment data at the Mariner Eccles Building, so really, for now it is all about waiting for the Fed. If pressed, I think they will be more likely to offer some new, more dovish, guidance as it appears they will not want to lose any positive momentum. That means the dollar should remain under pressure for a little while longer.

Good luck and stay safe
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