What Does The Fed's Change In Tune Mean For Markets?

In my last blog post in January, I wrote about how the US Federal Reserve reversed course to a more dovish tack. The most recent Federal Open Market Committee (FOMC) announcement and press conference with Chairman Jerome Powell show the Fed has continued with its dovish communication plan, and solidified its message that monetary policy is on a very different course than it was at the December meeting.

There was a strong market reaction to this last Wednesday, with equities higher, the US dollar weaker and the US Treasury curve steeper, as front-end yields lead the way lower.

In particular, the Fed's dovishness so far in 2019 seems to have given investors the green light to buy emerging market assets. If anything, the announcement of the 30 January that they will postpone hiking rates has accentuated this message.

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On Wednesday last week, the Fed held its target rate steady and communicated flexibility and patience. The Fed removed the longstanding language about further gradual hikes and indicated it would be open to adjusting the balance-sheet normalisation plan.

To me, this is all very consistent with the change in tone that started in the beginning of 2019 with Powell's talk at the American Economic Association (AEA) conference, and continued with similar commentary from many other Fed officials.

In particular, Powell is continuing to walk back his comments at the December press conference that so unnerved markets.

The Fed hiked in December as expected, but markets were laser-focused on Powell's comments that the pace of Fed balance sheet normalisation was on "autopilot." As I wrote in December, Powell seemed tone deaf to tightening financial conditions in late 2018, including a flattening Treasury yield curve, widening credit spreads and declining inflation expectations.

While there has been some market chatter in recent weeks about the Fed's thinking becoming more flexible on the balance sheet normalisation process, the Fed's announcement solidified that view and was likely a big driver of the moves we saw in financial markets last Wednesday afternoon.