The Overnight Report: The Fed Meets The Market

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By Greg Peel

The Dow closed up 74 points or 0.4% while the S&P gained 0.6% to 2027 and the Nasdaq rose 0.8%.

Nothing to see

The ASX200 opened lower yesterday on overnight falls in commodity prices but quickly recovered to spend the rest of the pre-Fed session chopping around the flat line.

Ultimately energy finished up 0.4% while the big fall in the iron ore price saw materials down 0.7%. Consumer staples was also down 0.7% but balance was provided by a modest recovery for the banks after Tuesday’s fall, up 0.5%.

The world then awaited the Fed.

Global Game

When the Fed made its first post-GFC rate hike in December, the expectation from both the FOMC and the market was that another four rate hikes would follow in 2016 at each of the quarterly meetings. Then the bottom fell out of the oil price.

The fall in oil had reverberations around the globe and forced a reduction in 2016 global growth expectations. While it seemed logical to assume that lower oil prices would feed increased consumer spending and provide a boost to industry through lower fuel costs, the market initially underestimated the impact of lower oil on the global energy sector itself and particularly on global oil producing nations. Meanwhile, China’s painful process of reform and subsequent slowing growth added to the angst.

Pretty quickly the market trimmed back its Fed rate expectations to two hikes in 2016 from four. Last night the Fed left its funds rate on hold at 0.25-0.50% as expected, taking one rate hike off the table. The Fed statement also lowered the central bank’s expectations to two rates hikes in 2016 rather than the previous four.

The Fed met the market.

The two main reasons provided for the downward revision were ongoing labour market slack, which is a nod to low wages growth and thus limited inflation pressure, and, in simple terms, the rest of the world. Since December, Japan has gone to negative rates, China, is upping the stimulus and the ECB has gone to zero and pumped up QE. If we consider the global economy as a closed shop, the Fed has actually achieved a March rate rise relative to the rest of the developed world without actually doing anything.

While the Fed statement could be considered neither more dovish nor more hawkish than the market expected, the US dollar index still tanked 1.1%, to 95.65. The greenback fell against the euro, yen, pound and Swissy and therefore only served to frustrate the central banks of those economies who are all trying to lower their currencies relative to each other.

The predicted two Fed rate rises are not set in stone, Janet Yellen was quick to point out. The Fed statement actually omitted the long-standing "we are data dependent" line this time around, but I think we can take "not set in stone" to mean unless things change, and change is usually evident in data.

Prior to the Fed release last night the US February CPI data were published. Headline inflation fell 0.2% due almost entirely to cheaper gasoline. The year on year headline rate has fallen to 1.0% from 1.4% in January. Stripping out energy and food, the core CPI rose 0.3% to be up 2.3% year on year.

The Fed’s inflation target is 2%, but not for the CPI. The Fed wants to see the personal consumption & expenditure (PCE) measure at 2% and that’s currently at 1.7%, and Fed forecasting does not have the PCE hitting 2% in 2016.

While the Fed acknowledges strong US jobs growth it also recognises a recovery in job seeking (participation rate), which is providing the drag on wage growth given there are still plenty of candidates ready to fill positions. The resultant lack of wage inflation is holding back overall inflation, and thus providing the Fed with the scope to be “prudent” in its policy.

While Wall Street clearly welcomed the Fed statement, a 74 point rally for the Dow is nothing reminiscent of the days of yore when hints of no rate rise would send Wall Street skyrocketing on the old “bad news is good news” theme. Indeed, the major drivers of last night’s post-Fed rally in US stocks were the materials and energy sectors, which were boosted by the weaker US dollar and the assumption the greenback will stay that way given the Fed has pulled back its hiking timetable.

Commodities

West Texas crude is up US$2.06 or 5.7% at US$38.51/bbl and Brent is up US$1.52 or 3.9% at US$40.29/bbl. Aside from the currency boost, oil rallied last night due to two other factors.

The weekly US crude inventory data showed that stockpiles continued to rise but at a lower rate than expected. Weekly production once again fell.

Qatar’s energy minister announced OPEC, Russia and other non-OPEC oil producers will meet in Doha on April 17 to negotiate an agreement to limit output.

As to why anyone can be excited about that last one is anyone’s guess. Readers may have noticed I’ve had an OPEC/non-OPEC meeting in Moscow pencilled in to the FNArena calendar this Sunday because that was the schedule set at the beginning of this month. I’ve been waiting to take it out and now I have, moving it to April 17. I will not be the least surprised if I end up moving it again.

Iran will not come to the party. End of story. If Iran’s not at the party then Saudi Arabia’s not joining in either. End of story. Investors need to focus on the weekly US oil data, including the above and each Friday’s rig count number, and on the number of defaults among marginal US producers. That’s where the oil story lies. OPEC meetings are a myth.

Gold is up US$28.20 at US$1261.30/oz which is no great surprise with the greenback down a percent. This jump nevertheless does not fully reinstate gold to where it was at the beginning of the week before nervous holders decided to square up ahead of the Fed meeting.

The LME always closes just as the Fed releases its policy statements so we have to wait until tonight to gauge the reaction for base metal markets. Last night all metals bar tin edged up a bit in anticipation.

After crashing back to earth, iron ore is up US80c at US$52.50/t.

And, of course, the flipside of the weaker greenback is a stronger Aussie, which is up 1.3% and back at US$0.7557.

Today

The SPI Overnight closed up 36 points or 0.7%.

If this proves accurate it will be the resource sectors leading the way today. The counterbalance may be the banks. US banks were among the worst performers on Wall Street last night given banks earn more with higher rates. The April RBA meeting will be interesting. With the Fed confirming a slower pace of raising, and central banks around the globe further easing since the March RBA meeting, what will our central bank want to do about that Aussie?

Australia’s February jobs numbers are out today. There’s some more fodder.

The Bank of England will hold a policy meeting tonight, but no one seems to care.

Myer ((MYR)) and OrotonGroup ((ORL)) will post earnings results today. Keep an eye on Myer. At 21% it’s the most shorted stock on the ASX. A better than expected result could spark a very sharp rally.

But that would require a better than expected result.

Rudi will appear on Sky Business today between 12.20-2.30pm.
 

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