Market doesn't know what to do with the FOMC

It never felt as if this Federal Open Market Committee meeting would be a major catalyst and we suggested that the bar to a hawkish surprise would be rather high, given the steep run-up in US yields all along the yield curve coming into the meeting. This meeting certainly wasn’t hawkish enough to clear the bar and the market reacted to that in a straightforward manner in the Treasury market, marking yields lower.

The currency reaction was a bit more of a headscratcher outside of USDJPY (lower), as the USD managed fairly well after some back and forth.

Fed Chair Powell’s press conference is a large part of the reason that we are stuck here without a strong reaction to what has unfolded, as he has a strong aversion to forward guidance and a very pragmatic take on the Fed’s stance, which makes it difficult to read anything into the Fed’s intentions, which was always the game with his predecessors. Powell did a thorough job of explaining the seemingly dovish elimination of the sentence describing the current Fed policy rate as “accommodative” as merely removing language that had lost its purpose and not signalling any change to guidance.

The economic forecasts were minor tweaks and saw no changes to 2020, with minor adjustments like the lowering of forecasted PCE headline inflation by 0.1% in 2019 (why bother?) and raising of the unemployment rate for 2018. The GDP forecast was raised to 3.1% for this year from 2.8% in June and to 2.5% for next year versus 2.4% in June, but none of the factors, the Fed believes, will drive higher inflation. While the median Fed Funds rate forecast is unchanged in the table, a look at the “dot plot” shows that the most notable shift is in 2020, where a more hawkish contingent of seven members is up at 3.5-3.75% (six members) and one is at 3.75-4.00%. A more dovish contingent of four members is forecasting 3.00-3.25%.

The June dot plot did not have this same pattern, with more consensus.

All in all, minor stuff and the US dollar actually did surprisingly well considering that US yields eased back in the wake of the meeting, with JPY crosses showing the highest immediate beta to yields pushing back a bit lower. There could be more tactical JPY upside on a further consolidation in the bond market as long as we remain near or above 3.00% in the US 10-year benchmark, the USDJPY bulls may hang in there for now.

Italy’s budget setting process is receiving more urgent attention now that Five Star's Di Maio is threatening a revolt if the budget deficit isn’t expanded above the current proposal in order to launch the citizen’s income initiative. He is out talking tough to reporters ahead of key budget talks today. Italy to Germany yield spreads are up some 15-20 bps this morning for the 10-year BTPs, but still in the lower portion of the range since the August highs. Significant headline risk there.

Elsewhere, the RBNZ stuck to its unchanged rate bias into 2020 and saw no reaction in NZ yields. For some reason, NZD challenging a bit stronger here versus the Aussie, with a big range low in AUDNZD near 1.0850 and the 200-day moving average just below here – feels heavy, even if we see little reason for a major stab lower.

Chart: EURUSD

Market trying to determine whether the FOMC was a significant event and whether Italy’s government is going to aggravate the old EU existential questions. Stress levels could rise if Di Maio gets his way and government attempts to drive a higher deficit above the 2.0% level as ECB purchases are winding down into the end of the year. In any case, the bull-bear line here looks like 1.1700, with a close significantly below looking to challenge the bullish case and risking the price action getting mired in the range back to 1.1500. Bulls need a vigorous new rally and challenge of 1.1800 to restart their engines for a drive into 1.2000.