EncoreFX’s daily market updates are written by our experienced and professional dealing team.
Fed Throws In The Towel
Published June 16, 2016
As expected the Federal Reserve FOMC left their overnight interest rate target unchanged at .5%. The FOMC also lowered their 2016 GDP growth forecast to 2.0%, down from 2.6% in December. And the FOMC lowered their forecast for GDP growth in 2017 and 2018 to 2.0% as well. The FOMC is still forecasting two interest rate hikes this year and next, down from three rate hikes previously.
By downgrading their GDP growth forecast, the Fed is acknowledging that their aggressive monetary stimulus over the past seven years is not having the impact on the real economy they’ve been hoping for. Unemployment is low at 4.7% but the labour force participation rate is at low levels last seen in the seventies. The student population has exploded as have those on disability. Capacity utilization is at a low 74.9% and consumer and corporate debt levels remain elevated.
As worried as they are about the lack of growth the Fed is also concerned about financial market imbalances so is reluctant to follow the ECB and Bank of Japan down the negative interest rate path. The message the market seems to have heard from the Fed is “we’ve done everything we can to stimulate growth through monetary policy, don’t expect us to do any more”. The impression is the Fed has hit the pause button or is on hold.
North American equity and commodity markets sold off after the Fed announcement and bonds rallied sharply. And this risk off sentiment picked up momentum overnight in Asia and Europe. The markets are losing confidence in the central banks and the market risk premium is rising as seen in the VIX now above 20.
Gold has spiked higher to a new 2-year high above $1,310 and the USD has fallen to a new two-year low below 105 to the Japanese yen. WTI crude has dipped below $48 again.
A more negative outlook for the US economy and a Fed on hold is certainly not positive for the Canadian economy and the loonie has sold off along with the lower oil price and lower bond yields. The 10-year GoC bond is now paying a 1.08% yield and the curve continues to flatten with the 10-2 spread at just 60 basis points. The Canadian dollar has slipped below 80 cents with USDCAD now above 1.3030.
In this morning’s data US headline CPI rose .2% in May and at a 1.0% annual rate. US core inflation came in at 2.2% and that has given the dollar further support. The Philly Fed Manufacturing Index beat expectations with a 4.7 print in June vs -1.8 in May.
Bottom line is markets are very much in “risk off” mode due to global growth and Brexit concerns and, in spite of the dovish Fed, this favours the US dollar along with the Japanese yen, Swiss franc and gold as a flight to safety plays.