Morning Commentary: The Federal Reserve – Comes Full Circle

Foreign Exchange - Morning Commentary

The Federal Reserve – Comes Full Circle

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Alan Rose
Alan Rose
Foreign Exchange Senior Trader
For those of you who were not around in the 1970s, the U.S. economy was characterized by high inflation and high unemployment creating a severe condition known as stagflation. Congress updated the Federal Reserve Act of 1913 in November 1977 to simplify the Fed’s job to have only a dual mandate: maximum employment and stable prices. In contrast, the ECB is only responsible for price stability.
The Fed is supposed to be above the fray, fly at 40,000 feet and not respond to stock market tantrums or Presidential criticism. But, the Fed messaging going back to October leaves a lot to be desired and in many respects has only added to the market turmoil and volatility as it appears to be responding to equity instability.
It appears the Fed has lost sight of its dual mandate and succumbed to monitoring the stock market and responding to the repeated harassment by President Trump. The Fed surprised and shocked the market yesterday by tilting so dovishly basically removing any likelihood of any further Fed interest rate increases in 2019. The Fed has come full circle from just three months ago, which is an amazing pivot:
October, Fed Chairman Powell: “we are a long way from neutral” regarding Fed monetary policy.
December, Fed Chairman Powell: the Fed will be “patient” before determining the next move in interest rates. He used the word patient eight times.
January, Fed Chairman Powell: “the case for raising interest rates has weakened somewhat.”
Why is all this important? It hurts the Fed's credibility as it appears that the Fed is succumbing to short term pressures and creates doubt in the leadership of the Fed to execute its dual mandate.  For the foreign exchange market, this sudden shift in stance by the Fed is a potential game changer as it opens the window to further USD weakness. In a different time and place, the USD would have really crashed, but with so much economic weakness elsewhere in the world (see below), the USD is only modestly weaker but much weaker against emerging market currencies. These developments need to be monitored closely until the next FOMC meeting in March.
  • EZ growth weakened from 1.6% YoY in Q3 to 1.2% YoY in Q4. This met expectations, but Italy has moved into a technical recession with two consecutive quarters of negative growth.
  • German Retail Sales for December were very weak dropping by 4.3% against expectations of a 0.6% drop; sales fell by 2.1% YoY. It was the biggest monthly decline since May 2007.
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