“Hot air from the Fed provides the thermal for this glider” Photo: Shutterstock
The Loonie is soaring like a hang-glider in a Rocky Mountain thermal, powered by hot air from Janet Yellen and the Fed. And the Loonie is not alone. All the G10 currencies took flight Wednesday afternoon after the Federal Open Market Committee seemingly shifted focus from a data dependent analysis to a more vague, ever-transitory outlook, where even the Committee members do not know what needs to occur for rates to rise.
The US dollar dropped roughly 1.2% against the G10 currencies immediately following the FOMC statement which is a rather substantial intraday move and evidence that traders were taken by surprise. And surprised they were.
Janet Yellen and her colleagues on the FOMC having been adamant that interest rate increases were not on a set path but were data dependent. In the run-up to Wednesday’s meeting, many economists who believed the Fed’s mantra that rate hike were “data dependent” were hawkish. They noted that, since the December meeting, rising economic growth, strong employment gains and a jump in core inflation met the data dependent requirements. They were pencilling in April or June rate increases.
Instead, the Fed focused on downside risks to the global economy, downgraded domestic growth forecasts and reduced rate hike projections from four in 2016 to just two.
With the clarity of hindsight, today’s FOMC about-face should not have been a surprise, certainly not as big as the FX reaction implies. The stage was set and the signs were there.
The G20 statement from the Shanghai meeting, February 27, expressed concern about downside risks to global growth and the International Monetary Fund warned that it was likely to downgrade its global economic growth outlook. Over the past seven days, the European Central Bank (ECB) announced a series of stimulus measures and cut interest rates. The Reserve Bank of New Zealand (RBNZ) cut interest rates, expressing concern about the deteriorating global growth outlook and on Tuesday, the Bank of Japan (BoJ) downgraded their economic outlook. Only the Bank of Canada maintained a “what me worry?” perspective.
Perhaps Wednesday’s FOMC move was pre-ordained by the G20. At least, that is what Steen Jakobsen, Chief Economist at Saxo Bank in Denmark, suggests. He wrote “This is in my opinion, the CONFIRMION of the incoming WEAK US Dollar policy, which not only is FED product but now condoned by ECB and BOJ (through their backing down from negative yield. The man has a point.
The Yellen Fed-Decisively, Indecisive
Since 1979, the world had grown accustomed to a US Federal Reserve and a Federal Open Market Committee that guided the American economy with a steady hand. The 1979-1987, Paul Volker led Federal Reserve was known for pre-emptive restraint and credited with taming runaway inflation.
His successor, Alan Greenspan held the chair from 1987-2006. He was adored by many market professionals and in 2002 a book was published with the heady title “Atlas Shrugged: Alan Greenspan, the World’s Most Powerful Banker”. The author Jerome Tuccille wrote about Mr. Greenspan, “he was credited with holding down inflation while keeping the economy growing throughout the longest and largest economic expansion in US history.” (he is also blamed for creating the 2008 financial crisis, but that’s another story)
Ben Bernanke followed him and held the chair for 14 years. He never got the press adulation accorded to Mr. Greenspan, but no one could accuse him of sitting idly by while the US financial market disintegrated. He initiated the Quantitative Easing programs, slashed US interest rates to zero and bailed out Wall Street. Many believe, he got the US economy back on its feet again following the 2008 financial crisis
And then, along came Janet, the first ever female Chair of the Federal Reserve appointed in February 2014. After her first twelve months, a Bloomberg article trumpeted that by any measure, she had a great first year.
It is now the end of her second full year and the trumpet player is off key. The Janet Yellen Fed is not so highly esteemed and deservedly so. The FOMC has been accused of sending mixed messages for the past six months as individual Committee members confused markets with contradictory views. Wednesday’s surprisingly doveish FOMC statement and press conference spot-lights a Fed in disarray, akin to the proverbial “deer in the headlights”, unsure how to react. Venison, anyone?
The on again-off again US rate hike debate contributed to the Canadian dollar rally but it was not the only factor. The 46% rally in WTI oil prices from the February low combined with a 180° turn in domestic interest rate sentiment and steadily improving data, fueled the gains.
The Bank of Canada held back cutting interest rates in January due to concerns about exacerbating the currency’s free-fall but there are no such concerns at the current exchange rate.
The ECB, Swiss National Bank, BoJ, RBNZ and the Reserve Bank of Australia all expressed concern about a deteriorating global economic outlook and three of them, RBNZ, ECB and BoJ, cut interest rates in the past 45 days. That leaves the door wide open for similar action by the Bank of Canada.
The FOMC reputation may be battered and bruised, but for global financial markets, they are still the biggest dog in the fight. The Committee members will not be happy with criticisms of their actions (non-actions), questions of their competence and grasp of reality. Don’t be surprised if the Fed speakers begin to deliver a consistent, less opaque message for markets and if that happens, the US dollar will rally taking USDCAD along for the ride.
By David Marks, Agility FX Analyst