Did the market reaction after last week’s 25bps rate hike announced by Janet Yellen and the FOMC (Federal Open Market Committee) leave you scratching your head? The dollar went down, Wall Street rallied with the S&P spiking near all-time highs, commodities including gold rallied … was this what you were expecting? Well, if not and if you are scratching your head, be comforted that you are not alone. Many others are also scratching their heads, from amateur investors to seasoned industry veterans.
As typical with post game couch side review, explanations are being created to match with what happened. One of the explanations that is being repeated is that this was a dovish event on the part of the Fed. A bit surprising because in the recent past, this would most likely have been considered a hawkish move from the Fed, as with most rate hikes, along with the maintained position on a forecast of three hikes this year. Apparently for this latest FOMC meeting to have been considered hawkish the Fed would have had to announce an increase in the anticipated number of rate hikes and there would have had to have been a change to the notorious dot plot of Fed member positions.
If you do not buy the explanation that the announcement was dovish, another plausible explanation is that this is the kind of behavior just driven by ongoing euphoria of the late stage bull market. Jan Hatzius, chief economist of Goldman is quoted as saying that this market reaction does not really make sense and was more akin to what you would expect if it was a 25bps move in the other direction – in other words how the market would have reacted if the Fed had announced a rate cut.
Another dynamic at play here is the bullish rhetoric of Trump, decreasing corporate taxes and regulation, infrastructure spending, US dollar repatriation which would lead to a stronger dollar but also more difficulty for the US economy versus the Fed who want to be sure they have enough powder to keep inflation in check. Another elephant in the room is all of the outstanding US debt which would become impossible to service if rates get too high.
Nothing is ever in isolation and another event with a side-effect impact to the dollar was that the Dutch elections were on the same day as the Fed announcement and there was a boost to the Euro exchange rate due to the non-populist outcome of the Dutch elections. Next month will see additional events outside the US that will have side effects towards the US dollar. Sentiment towards the Euro will surely be impacted as the French elections start heading towards a climax over the next two months as well as the UK’s self-imposed deadlines for Brexit talks next week. In addition, both the ECB and BOJ will be convening towards the end of April and these sessions will surely add to the exciting things to watch out for next month. The next FOMC session is not scheduled until June 13-14 and that session will also be associated with a Summary of Economic Projections and a press conference by the Chair.