Markets Give Powell a Muted Welcome
Jerome Powell, President Trump's handpicked Federal Reserve chairman, chaired his first meeting on 21 March 2018 and ratified the generally expected quarter-point rate hike. The 25-basis points hike raised benchmark interest rates from 1.50% to 1.75%. This is the highest rate in over a decade and only the sixth-rate hike since the 2008/9 global financial crisis. The accompanying rate statement talked up economic growth and outlook but cautioned that inflation cannot be overlooked. This effectively made a case for further gradual rate hikes.
Still, the dot plot remains a total of 3 rate hikes for 2018, even though there were strong tailwinds for even more aggressive hikes. Five FOMC members deemed 4 rate hikes to be proper this year, the same number as those who viewed 3 hikes to be appropriate. The median remained at 3 rate hikes, as two Fed members thought only 1 rate hike would suffice, and 1 other member believed 5 hikes would be appropriate.
Furthermore, the median projections for 2019 and 2020 increased. The median dots show 3 rate hikes in 2019 and 2 more in 2020. This would leave the benchmark policy rate at 3.4% by the end of 2020, which means that FOMC members expect to raise the rates above the long-run rate of 2.9%.
The rate hike was largely expected, but what was more important for the market was Mr. Powell himself. This was his first address in his new position, and under the controversial Trump presidency. The market saw whipsaws as Powell continued his address, with FX options prices being particularly choppy. Powell had the unfortunate coincidence of hiking rates a day after President Trump announced trade wars with China, something that would cause massive worry among market participants.
During his press conference, there was much emphasis on the need to disregard median estimates. Powell was even later more forthright, saying that the Fed had made only one decision on the day - raising interest rates by 25 basis points. This was a clear indication that dots will not influence future Fed decisions, and that they will be guided or will remain open to new data or information. Basically, there will less Fed verbosity, and more reality.
FOMC members also raised growth and inflation forecasts. In December, the growth forecasts were 2.5% and 2.1% for 2018 and 2019 respectively. It was raised to 2.7% for 2018 and 2.4% for 2019. The forecast for core PCE or Inflation is 2.1% for both 2019 and 2020, with Powell reiterating that the link between the economy and Inflation remains in place, albeit weakening.
While there has been a change in projections, relative to December, the pace of the rate hike schedule is still slower than in previous tightening cycles. Underlining this view, Powell said that the Fed is trying to take a 'middle ground' by striking a balance between hiking rates too quickly or too slowly.
Impact on Financial Markets
The Fed hiked rates and upgraded the economic outlook, but instead of the US dollar gaining ground, it weakened against all the major currencies. FX options quoted the Canadian dollar as the best performing currency soon after the Fed presser. The loonie gained over 1.5% against the greenback. The other major currencies (Australian dollar, New Zealand dollar, Euro and Pound) all posted gains of over 1% against the US dollar.
Gold and other precious metals also edged higher, indicating that investors are moving to safe haven assets, thanks to inflation worries.
Stocks have been the hardest hit financial asset group, with the S&P 500 consistently ticking lower since. From sustaining well above 2700, the index has posted its sharpest decline since January, and is now at close to 2018 lows of circa 2580.
Yields, on the other hand, have moved higher with 10-year treasury notes climbing to 2.9%.
The Trade War
The Fed rate decision, as earlier stated, was the highlight of the day. But the moves in the financial markets took cue from headlines of a looming trade war involving two of the world's largest economies: The United States and China. A day before the Fed rate hike, the US announced $50 billion worth of tariffs on Chinese imports. China retaliated with tariffs worth $3 billion in two stages. Compared to $50 billion, $3 billion is smaller figure, but still a statement of intent. China hopes this will lead to constructive dialogue, but the markets do not exactly trust President Trump to extend a diplomatic hand.
Powell himself acknowledged that the issue of tariffs was brought up by an FOMC participant. He noted that trade, initially a low-profile risk, has now become a prominent danger to the economic outlook. This candid acceptance could have fueled even more uncertainty in the market.
A New Era
The markets might have given Powell a muted welcome in his maiden presser, but that is part of adjusting to a new era at the Fed. The markets no doubt appreciate a less verbose Fed that is more data driven. They will also probably love a clear talking Powell.