Markets React To Fed Funds Decision

Markets React To Fed Funds Decision

The financial markets on Friday morning were still reacting to the Fed’s decision to keep rates on hold, an outcome that came contrary to the expectations of a sizeable chunk of economists.



Markets React To Fed Funds Decision
Markets React To Fed Funds Decision

The decision to hold off until there is further evidence that inflation will return to target seems quite reasonable to me, given the latest reading on US CPI showed a fall in prices and the current uncertainties over global growth. The stock market reaction to the decision and Janet Yellen’s ensuing press conference was fairly positive on Thursday afternoon, but things have taken on a more negative slant on Friday, with sharp slides in equity prices for developed markets. Friday has seen further declines in the US dollar on top of Thursday’s falls in the currency.

The dollar index, a measure of the dollar’s strength against a basket of six leading currencies, slid 0.25%, while the Aussie dollar and the Canadian dollar both made pronounced gains against their US counterpart, AUD/USD jumping 1.25% to 0.7263 while USD/CAD fell 0.92% to 1.3059. The Aussie dollar was lifted by comments made by Reserve Bank of Australia Glenn Stevens to the Australian House of Representatives Standing Committee on Economics. Mr Stevens indicated his satisfaction with how Australia’s economy has negotiated recent changes in the global economy, saying, ‘There is still a pretty good chance that we will come out of this episode fairly well, and much better than we came out of previous episodes of this type.’ This upbeat assessment has reduced speculation that the RBA will implement another rate cut at its next meeting.

Possibly adding to the day’s volatility is the phenomenon of quadruple witching, with four classes of September futures and options contracts expiring on Friday, which has historically been associated with increased trading volumes and greater price oscillation.

The US dollar’s weakness stems from the relative dovishness of the Fed’s position — though 13 of the 17 participants still think there will be a rate rise in 2015, this is down from the 15 who thought this way at the June meeting. Back in June, the remaining two participants indicated 2016 was their choice for an appropriate timing for policy firming. In the September meeting, the number plumping for 2016 had grown to three, while one further policymaker opted for 2017.

 Ms Yellen in her press conference, meanwhile, elaborated on how low inflation had impacted on the committee’s thinking, saying ‘Inflation, however, has continued to run below our longer-run objective, partly reflecting declines in energy and import prices. While we still expect that the downward pressure on inflation from these factors will fade over time, recent global economic and financial developments are likely to put further downward pressure on inflation in the near term. These developments may also restrain US economic activity somewhat but have not led at this point to a significant change in the Committee’s outlook for the US economy.’

Ms Yellen has stressed several times that the overall path of rate rises (expected to be gradual) is more important than the timing of the first rate hike. Clearly the Fed is remains on a diverging path to other major central banks, and within that context, it is reasonable to think there is only so far this dollar weakness can go without a serious rethink of the expected trajectory of the Fed’s monetary policy.


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