The most boring FOMC meeting in years, but financial markets love it

The unanimous decision by the Federal Reserve to keep interest rates on hold on Wednesday was widely expected by the market. However, the key takeaways from the decision have caused US stocks to jump to session highs and Treasury yields to fall. As we have said in previous notes, it is what the Fed says and not what they do, that has the power to move markets. Today, although the Fed held open the door for more rate increases and said that “evidence of above potential GDP would warrant a hike”, they also said that the Fed is attentive to the “increase in longer term yields”. This last statement has been enough to trigger a 1% rise in the S&P 500 and a 1.7% increase in the Nasdaq as the market believes that the recent surge in 10-year yields has negated the need for further rate hikes. There has also been a broad-based drop-in Treasury yields, with the 10-year yield down 18 basis points at 4.74%, the lowest level since mid-October.

US economic data plays ball

The decline in yields is worth watching, as there has been debate over what would happen if the 10-year yield breached the 5% level. That hasn’t happened so far, and there is an argument that recent news flow could trigger a broader decline in yields in the coming days. US manufacturing activity fell by more than expected in October, the ISM Manufacturing survey fell to 46.7 last month, its 12th straight decline. The detail within the report was also bearish, with concern that there could be further declines deeper into contraction territory as most sectors are reporting soft levels of demand. The one sector with decent demand is food production, according to the ISM.

Fiscal policy to determine where markets go next

Also weighing on yields was news that the US Treasury was slowing the pace at which it issues longer dated debt. This could be the most important development to weigh on yields in the medium term. Back in August, the Treasury announced that it would increase the issuance of 10 and 30-year debt to fund higher levels of government spending. After that announcement Treasury yields surged to their highest level in 16 years. Wednesday’s announcement could go some way to neutralise the impact of rising debt issuance on Treasury yields, also known as the term premium, and could have a calming effect on financial markets more broadly. While US government spending is set to rise, the Treasury will raise the auction sizes of 2 and 5-year notes instead, by $3bn a month. 10-year and 30-year auctions will see their issuance rise by $2bn and $1bn respectively. Added to this, the Treasury has reduced the size of next week’s quarterly refunding auction to $112bn from the original $114bn. In a fiscal world where there is little to cheer about, this was welcome news.

Bank of Japan loosens yield curve control, but with a caveat

This development is worth watching. While monetary policy remains important, there is no doubt that we are moving into the “boring” phase of policy decisions, with the chances of rate hikes or cuts unlikely for the foreseeable future. The BOJ probably has the most interesting future, as it ponders whether or not to end yield curve control. The BOJ announced on Tuesday that it would loosen its grip on yield curve control, stating that the 1% upper bound on the 10-year yield was not a rigid cap, and removed its pledge to defend this level with unlimited amount of bonds. However, the BOJ watered down its message when it said that they still have not seen enough evidence to feel confident that trend inflation will sustainably hit 2%, which sent the yen tumbling. The 10-year JGB yield is higher by 6 basis points so far this week, but it still remains below 1% at 0.95%, as traders focus on Treasuries and a more positive mood permeates financial markets, limiting upward pressure on JGB yields.

FX impact

The decline in Treasury yields is down to fiscal policy, and not monetary policy. Thus, if you want to know where Treasury yields go next, watch fiscal policy and not monetary policy. Since Treasury yields and overall risk sentiment have an inverse correlation, then fiscal policy in the US may also determine where stocks go next. From an FX perspective, the focus on fiscal policy and lower Treasury yields means that the dollar is lower across the board on Wednesday, apart from against the euro, where it is making a small gain. USD/JPY is also down, and is back below 151.00, after reaching a high of 151.50 in the aftermath of the BOJ meeting. The dollar index is consolidating below 107.00, and since the FOMC meeting has boosted the outlook for the risk sentiment, we may see this level reinforced as serious resistance as we move through November.

Ahead tomorrow, we expect a similar message from the Bank of England as we have seen with the Federal Reserve. The BOE’s latest CPI forecasts worth watching to see if they are increased due to the recent rise in commodity prices. From a market’s perspective, we will be looking to see if GBP/USD can try to regain the $1.22 level, if the dollar keeps weakening.