Today's Statement sends a clear message that the Fed remains committed to its normalization agenda. As I wrote at least a few times last year, monetary policy normalization is a broad concept, not limited to return of policy rates to more "normal" levels. Normalization also includes a gradual exit from QE (which began in 2013 under Bernanke's leadership) and gradual return to normal FOMC communication. The chart below illustrates the progress on the Fed's withdrawal from forward guidance:
Policy communication is slowly returning to normal. Calendar and data based guidance are the thing of the past for the most part and the Statements are becoming shorter. If the global economic system normalizes, too, the Fed will most likely return to the regime where they will keep the market guessing as to what their next move will be.
There was nothing particularly special about the today's statement. As expected, no hikes were announced. The committee acknowledged the slowdown in economic growth towards the end of the year and the further fall of 5y5y breakeven inflation. However, the word count declined slightly compared to the last meeting and the tone of their language continued to evolve in a way that indicates further tightening.
On the dovish side, the statement now mentions that the committee is closely monitoring global economic and financial developments and is assessing their implications for the labor market and inflation, and for the balance of risks to the outlook. This indicates that the Fed remains aware of the importance of the stock market for the economy. They are also aware of the ugly price action seen over the last year or so and would not want to be perceived as an immediate cause of any material decline of the American people's paper wealth in the near term.
In order not to generate market volatility, my opinion is that the Fed will continue to hike in the same fashion as they did in December last year. Specifically, they will not actually hike until the markets are ready. In order to prepare the markets, they will have to stick to their hawkish script. They will continue to project higher policy rates compared to the markets, but will not actually hike until the front eurodollar contract is pricing in the extra 25 bps. This will ensure that policy rate hikes will have a minimal impact on market volatility.
The current statement caused the S&P 500 index (NYSEARCA:SPY) to drop more than 2% intraday. However the index appears to be holding the uptrend support at the time of writing, providing a very attractive opportunity to add to bullish positions.
Click to enlargePerhaps an even more attractive opportunity is in the commodity markets. As risk appetite fell in recent weeks, gold (NYSEARCA:GLD) rose towards its 2012 key downtrend resistance (see chart below). The downtrend should be re-established once the volatility falls, risk appetite returns and the markets become gradually more comfortable with another 0.25bp hike in spring or summer.
Disclosure: I am/we are long SPY.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I am long SPY and short GLD