Fed – “inflation mandate” reignites deflation talks

In line with our expectations none of the monetary parameters were changed yesterday by the Fed. The FOMC signaled readiness to act whenever necessary (perhaps in November) – also in line with expectations, and “enriched” the statement with the inflation mandate talk – quite unexpectedly. The inflation targeting talk used to be up and down in the US and the Fed usually played down benefits of this approach. Nevertheless, yesterday it indicated that a forecasted inflation in the US will to low for their liking (and according to their “mandate”). The Fed didn’t signal what inflation fulfill the mandate so there is no official inflation targeting but the market saw the inflation talk as a signal of deflation worries among (at least) some members of the Fed, including the chairman. Here are the consequences:

EURUSD – Augusts’ high within reach

The euro gained clearly vs the dollar, following a few days period of limited volatility. The market eyed Augusts’ high of 1,3334 for quite a while but Irish worries stopped the rally for few days. However, Ireland sold bonds yesterday and freed the euro from the sentiment baggage. In a reaction to the statement, the pair climbed above a local resistance of 1,3160 and surged towards 1,3334.

The Fed seems more eager and more straightforward in fueling the economy than other major central banks (especially the ECB) which may cause the EURUSD to climb in a longer run. The climb might include, however, some rapid sell-offs on resurfacing of the fiscal issues in the euro zone from time to time. In a short run, the 1,3334 is a key level. Should it be broken, the pair may eye as high as 1,39 – 61,8% retracement of the slide from Dec’09-Jun’10.

USDJPY – limited gains of the yen

Considering a rally on the EURUSD, a slide on the USDJPY (to 84,76) looks minor, especially as the pair was in a narrow range consolidation (85,20-90) for few days. That might suggest interventions from the BoJ – a rapid retracement of the pair would be fatal for the whole fx interventions strategy. Nevertheless, this new rhetoric from the Fed certainly caused discontent in Tokio. In a reaction to the statement US market rates went clearly down (especially on longer maturities) and unless circumstances change, a rebound on the USDJPY may be delayed again. These circumstance include US labor market data for September. The Japanese are left to hope the release will be strong - reversing course on the US fixed income and the USDJPY. The release is still more than two weeks away.  

Equities – a moderate optimism

An initial reaction on equities to the statement was clearly positive, with major US indices climbing by nearly 1%. The reaction was reversed before the bell, but the futures gained once again in Asia. Such reaction may be attributed to two factors: a schematic reaction (dovish statement – good for equities) and a dominating (this time bullish) sentiment. Should the deflation worries intensify, there would be a little to celebrate for the equities though. So for the moment, investors on equity markets may hope for a gradual recovery to continue and treat the Fed’s policy as a bonus.

Events to watch – BoE minutes

Wednesday offers investors a time to digest the Fed’s statement. Releases like US mortgage applications (7.00 ET, 13.00 CET) or new orders in the euro zone (5.00 ET, 11.00 CET) are unlikely to have a noticeable impact on the market. In those circumstances, a release of the BoE’s minutes (4.30 ET, 10.30 CET) may dominate the European trading on the forex (or at least GBP). The rhetoric adopted by the Fed may have a dovish influence on the Bank of England.

Przemysław Kwiecień, Chief Economist

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