The Overnight Report: Patient Fed, Volatile Market

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By Greg Peel

The Dow closed up 288 points or 1.7% while the S&P gained 2.0% to 2012 and the Nasdaq jumped 2.1%.

The bargain hunters poured back into Australia’s energy stocks yesterday, spurred on by a mild bounce in the West Texas crude price. These guys are either gluttons for punishment or simply certain that one day it will be the right trade, and that day could just as well be this one. The market in general chimed in to send the ASX200 up almost 40 points after lunch, despite another fall on Wall Street and falls in metal prices, before fading away in the afternoon. Energy nevertheless finished up 3%.

There was no doubt some squaring up ahead of last night’s Fed statement.

The Fed left the words “considerable time” in its statement last night, in reference to the period between the end of QE and the first rate rise, but acknowledged that because QE ended back in October, its relevance as an anchor point for rate rise expectations is now diminishing. Thus the committee introduced a new word, “patient”, as a reference to just how quickly monetary policy might be tightened.

Wall Street liked “patient”, as it implies the Fed is likely to leave its cash rate at zero for longer and not be too hasty to hike. What we thus saw at 2pm was a spike in stock prices and oil prices and a plunge in the US dollar and bond prices (spike in yields), given this is a “dovish” word. But Janet Yellen’s press conference took some of the gloss off the dove.

With regard “considerable time”, Yellen suggested that implied there would not be a rate rise at the next two meetings (which are six-weekly). That’s “considerable”? And in terms of “patient”, Yellen suggested that policy is very much “data dependent”, hence strong data could push the Fed to move sooner and not so strong data would keep things at bay for longer. The most important data are labour-market related, and here the Fed sees solid jobs growth, labour market slack gradually diminishing, and the unemployment rate falling towards 5.2% “maximum employment”.

In terms of inflation, the Fed expects core inflation will eventually move back to its target rate of 2% but acknowledges the fall in the price of oil is holding headline inflation at a low level. The committee believes this oil shock will prove “transitory”, and thus an inflation rate below target will not stop the Fed from raising its rate if it feels the time has come.

In terms of the rest of the world, and potential problems stemming from the oil price plunge, Janet Yellen emphasised the word “transitory” at the press conference, and in particular does not see Russia as having much of an impact on the US.

So where are we left. Absolutely nowhere closer to knowing when the Fed is going to hike. Initial exuberance wore off as the press conference proceeded, given Yellen’s comments proved a lot less dovish than the statement.

One thing Yellen did emphasise is that the Fed will continue to rollover its Treasury and asset-backed bond holdings, thus maintaining its balance sheet, which in itself will aid policy accommodation. Thus again we note QE is not really “over”, it’s just not growing anymore.

And speaking of inflation, last night it was revealed the US headline CPI fell 0.3% in November, its biggest fall since December 2008, after having been flat in October. No prizes for guessing why. The annual inflation rate has fallen to 1.3% from 1.7% in October.

The core inflation rate, which excludes food and energy costs, rose 0.1%. Annually it slipped to 1.7% from 1.8%. It must be remembered while the core rate excludes direct energy costs, there will be a trickle down impact to a lower cost of business. This might be enjoyed by businesses as improved margins but could also be passed onto customers to boost sales, in which case core inflation would fall.

It is for this reason Janet Yellen last night noted that low inflation would not prevent the first Fed rate rise, given the impact of the oil shock should prove “transitory”.

West Texas crude traded as high as US$58.98/bbl last night, or up three dollars, before falling back to be a mere US3c higher at US$55.99/bbl. Note that the oil markets don’t “close” at the end of the day, so FNArena’s published prices represent a local morning snapshot. Brent is down US6c to US$59.80/bbl.

The US dollar index rallied strongly last night ahead of the Fed statement, fell all the way back on the statement release, and then started rallying during the press conference. It’s up 0.9% at 88.93. The US ten-year bond yield followed a similar path before deciding on a 6 basis point gain to 2.13%. Gold shrugged, and is steady at US$1194.00/oz.

The Aussie was already trending down again in yesterday’s local session and it, too, suffered extreme volatility around the Fed statement, but is down nearly a cent to US$0.8130 over 24 hours.

Compared to the oil exchanges, the LME is old-school, and the shutters always come down just as the Fed statement is hitting to wires. Prior to the Fed statement the US dollar was stronger, which possibly explains 2% falls for lead and nickel and 3% for tin, but then aluminium, copper and zinc were all slightly higher at the close. Tonight will tell the tale.

Iron ore fell US20c to US$67.90/t.

But back to US stocks. The Dow was already up around 150 points before the Fed statement hit the wires, as the biggest fall in CPI in six years drove assumptions of renewed dovishness. Initially the statement seemed to confirm this (“patient”), hence the Dow spiked to 300 up. Yellen’s press conference poured cold water on dovish expectations, so the Dow fall back to be up only 150 at 3pm, and then someone said “what the heck, let’s just buy it anyway”.

The 288 point gain for the Dow appears to be at odds with a 6bps jump in the ten-year yield, if one assumes Wall Street would rather see rates lower for longer. But as I point out after every Fed meeting, the “smart money” does not play silly-buggers with the rest of the market on Fed-day. The smart money takes the time to assess Fed policy nuances overnight and then makes its trade the next day.

The SPI Overnight closed up 62 points or 1.2%.

Who’s that guy in the red suit in front of the chalkboards?

There may yet be enhanced volatility on the ASX today as it is our own “quadruple witching” expiry day, while ANZ Bank ((ANZ)) and National Bank ((NAB)) are among those companies holding AGMs today.

Today also sees the release of New Zealand’s September quarter GDP result. The Kiwis take longer than most to calculate their GDP given every time the statisticians try to count the sheep, they nod off.
 

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