The Fed held rates at 25-50 bps at its March 16th FOMC meeting. The street was calling for a rate pause, despite firm economic data lately, though most market participants nodded to the appearance of the some hawkish rhetoric in both in the press conference, accompanying statement, and Fed projections (“the dots”). Markets were taken by surprise as Yellen sided with the doves of the FOMC and touted “proceeding with caution” language. All in all, the event was upbeat, on the back of the shift in policy stance, and most major asset classes finished firmly in the green, apart from the US Dollar which came under pressure post the release.

The main headline out of the press conference was the change in economic projections, in particular the projected interest rate glide path. The Fed’s economic projections, from their Jan 27 meeting, had 4 hikes baked into the “gradual” glide path for 2016. The median rate came off to just 0.90% vs 1.40% prior. The Fed has also pared back GDP estimates; 2016 estimates were downgraded to 2.20% vs 2.4% prior. In terms of PCE Core inflation, the Fed’s preferred metric, no changes were made for 2016 or the terminal projected rate, though the projection for 2017 was brought back slightly to 1.8% vs 1.9% prior. The employment outlook for 2016 remained unchanged, with the unemployment rate pegged at 4.7% vs the current rate of 4.9% (As per the employment change release for the month of Jan). The unemployment rate was projected to tick back 0.1% in both 2017 and 2018 to 4.6% and 4.5%, respectively.

The projections demonstrate a dovish shift and coincide with the Fed rhetoric out of the press conference, after the release. Fed’s Yellen (Fed Chair, Stance: Neutral) expressed that the Fed will need to “proceed cautiously”; when she was discussing the improving employment situation’s impact on the likeliness of further hikes amidst a near zero rate environment. Yellen also highlighted the impacts of global economies, as a source of feedback into future policy, when she was mentioning that global forecasts are down significantly.

Market participants have continued to doubt the Fed’s glide path since it began being published, as a means of Fed transparency improvement. The chart above, clearly shows that currently, short term implied rates have continually undershot the Fed’s projections, by a wide margin. For the some time now, convergence from top (the Fed) to bottom (the current market implied rates), rather than the other way around, has become a reality. It may take several hikes and drastic change in the economic outlook both in the US and globally to dissuade traders from their view. The Fed has expressed that the path forward, for rates, will be “gradual”, however traders have taken on positions that are in line with very little-to-no policy action in the near future.

At present, the Fed has projected 2 hikes for the year of 2016. Currently, markets are fully pricing in a single hike post the Dec 14 2016 Fed meeting, with the Sep 21st meeting being another likely candidate that currently has just above an even coin-toss odds pegged to it.

Looking to the Fed language employed this time around, the statement, has more of a dovish tilt towards growth. The committee has also made sure to include a new sentence highlighting global economic and financial development concerns as feedback that may cause risk to their outlook and policy going forward. The statement also has shifted focus onto, the long ignored, second half of the Fed’s mandate, inflation. It appears that there may be some additional weight given to inflation metrics as the economy nears the 2% threshold, though it should be noted that the Fed has not altered their inflation outlook short/medium/ or long-term from the previous statement. A parsed and annotated comparison of the current and prior FOMC statement are presented at the bottom of this article.

The Fed has clearly expressed that it has become a necessity to tread carefully as far as future rate increases are concerned, or “proceed cautiously”, and it remains likely that a major uptick in domestic, as well as global, economic metrics may be compulsory prior to the next hike, rather than a time decay to the two projected hikes.

In the US, Manufacturing has been advancing steadily and showing signs of life. The latest ISM was upbeat 49.5 (act) vs 48.5 (exp) up from 48.2 (prior). It should be noted that, that reading was for the month of February. The most recent, correlated, manufacturing data for the month of March has pointed higher with both Philly and Empire delivering massive upbeats against expectations as well as priors.

Employment has been strong, with the most recent blockbuster payrolls print of 242K (act) vs 190K (exp) up from prior 172K. The unemployment rate ticked back to 4.90% (act) vs 5.00% (exp) as well, showing strong signs of labor market growth.

Lately, inflation has crept higher, in line with the Fed’s recent nod to the long forgotten second mandate. The Fed’s preferred inflation metric PCE Core y/y has advanced to 1.70% (act) vs 1.30% (exp) and has been advancing over priors for the past 3 months, though remaining below the Fed’s 2.00% threshold. CPI Core y/y inflation numbers paint the same picture, with the February reading arriving at 2.30% (act) vs 2.20% (exp).

Retail Sales and GDP remain sluggish. Though, it should be noted that the GDP number is now stale, as it dates back to Q4, and traders will be eyeing a fresher release carefully to gauge the future path of Fed policy.

Most major asset classes finished firmly in the green on the back of the dovish Fed meeting, though the USD came under pressure as prospects for further hikes in the near term dwindled. S&P futures currently trade 2041.00 up 29 handles from the lows of 2012.00 just before the meeting, as equity traders piled into long trades after being waived in by the doves of the FOMC. Crude oil has pushed higher to $40.25, above the $40 level for the first time since Jan of this year, up nearly $2.50 since just before the release. Gold spiked $32.00 on the release and is trading $1263.00, well off of the $1231.00 level before the announcement. The T-Note now trades 129-07 up a full handle since the news hit. The US Dollar Index sunk like a lead balloon and trades 94.75 down from 96.82.

The US Yield curve front-end-lead-bull-steepened in line with the now dovish and “cautious” Fed. Yields on the 2 year notes came off 11 bps, further back in the curve the 10 year note fell just 6 bps. TUT (2s over 10s spread) popped 5 bps as the spread between the maturities hit 104bps. It is likely that traders will continue to pile into bull steepeners so long as they remain unconvinced of the Fed’s proclivity to act.

Risk on sentiment has been prevalent in the market place, and has brought bonds and gold along for the ride. The Fed’s path forward and the economic developments out of the US and globally remain uncertain, though for the time being, traders have been given the green light. As it stands, there may need to be an abundance of overwhelmingly positive economic data in order to cause traders to re-evaluate their doubts regarding the Fed’s proposed interest rate glide path.

-David Felkai Uptick GMA.

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