Morning Commentary: Who Should You Believe – The Fed or the Markets?

Foreign Exchange - Morning Commentary

Who Should You Believe – The Fed or the Markets?

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Alan Rose
Alan Rose
Foreign Exchange Head Trader
Yesterday, the Fed raised interest rates as expected for the ninth time in this interest rate cycle (starting in December 2015) and the fourth time this year. They downgraded the number of Fed rate increases for next year from three to two and implied that they would continue to be data dependent but remained upbeat about the economy in general.
 
That was not what the markets wanted to hear as they expected the Fed to be more sensitive and dovish to the recent market signals about concerns about future growth. Instead, the Fed’s language appeared to be almost dismissive of recent financial market signals. Markets think the Fed is making a policy mistake - U.S. and global equities collapsed yesterday and overnight. U.S. interest rates reacted strongly with the yield curve flattening further and the U.S. dollar has weakened sharply against almost all the major currencies.
 
Who is going to be correct about the state of the economy going forward and who should you believe…the Federal Reserve or the markets? A number of key market participants including the WSJ have cautioned the Fed about moving too fast to normalize interest rates and advocated for the Fed to stand pat and not raise interest rates yesterday. These commentators have history on their side as there have been 13 Fed tightening cycles in the post-World War II era. Ten of those tightening cycles ended with a recession (77% of the time). To the Fed’s credit, they were able to engineer a “soft landing” for the other three.
 
Personally, I have more confidence in the markets ability to forecast correctly than in the Fed’s ability as too many of the Fed’s monitoring indices are looking backwards. I wish the Fed had not raised rates yesterday and sat back to watch how the global and U.S. economy continues to unfold as we are long in the tooth on this expansion. For all the smart people with PhD’s at the Fed and elsewhere in Washington, no one there correctly predicted the Great Recession or the Dot-Com bubble. For those involved in the fx markets, the U.S. dollar (DXY) is looking increasingly toppish.
HERE ARE THE KEY NEWS STORIES FROM OVERNIGHT:
  • The Bank of England kept interest rates unchanged as expected at 0.75%; the vote was 9-0 to keep interest rates unchanged as uncertainty surrounding the Brexit negotiations remains a troubling concern for the central bank.
  • Sweden unexpectedly raised interest rates overnight and the Swedish krona is one of the top performing currencies overnight appreciating by nearly 1.50%. The Swedish central bank (Riksbank) raised interest rates for the first time in seven years. They raised interest rates to -0.25% from -0.50%.
  • The Philly Fed Business Outlook for December came in weaker than forecast at 9.4 against expectations of a gain to 15.0 and was weaker than November’s print of 12. In addition, U.S. jobless claims rose slightly to 214,000 from 206,000 the week before.
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