Mizuho daily - Of Calms & Storms and Will the Fed do an ECB?

By Vishnu Varathan, Head, Economics & Strategy, Asia & Oceania Treasury Department, Mizuho Bank, Ltd.,

Of Calms & Storms

As cliché as it may sounds, markets appear to have conceded to the (pre-FOMC) calm before the storm; with currencies sticking to familiar levels and US bonds and equities barely moved. After all, EUR found no inspiration to stray from 1.19 levels, USD/SGD hugged mid-1.34 as did AUD the mid-0.77 (despite a brief attempt at 0.77) and USD/JPY is fairly sticky around 109.

While (10Y) UST yields have edged back a touch above 1.6%, this appears to be more shuffling around 1.6% before Fed speak, than an emphatic move.

Meanwhile, Dow (-0.4%) and S&P500 (-0.2%) are just easing off recent record highs while Nasdaq ekes out a 0.1% gain.

But equally, it was the storm before the calm.

Dismal US industrial production data that blind-sided consensus for a mild pick-up, and ought to have setback markets, were put to rest as the unseasonably bad storms that interrupted industry and activity in the US. Tellingly, US retail sales disappointment, impacted by the storms, was greatly exaggerated (vis-à vis consensus) due to the massive upward revisions to prior month’s data.

The wider point being, the calm after the storm should see a resumption of emphatic pick-up. Speaking of storms and calms, there appears to be some reassessment, and consequent relative calm that broader EZ vaccination plans will not be derailed, even if somewhat delayed; after a storm of concerns about potential side effects from AstraZeneca.

For now, calm appears to be the default for markets that are inclined to sit by the side-lines ahead of the FOMC meet. But the potential for a mini “storm” from UST yield volatility, if the Fed is not deemed to have done enough to placate markets, is reason to banish complacency.

FOMC: Will the Fed Do an ECB?Today’s FOMC meeting will arguably be very closely watched, perhaps even fussed over, despite the wide consensus of no significant changes to policy setting. And not just for likely upgraded economic forecasts reflecting fiscal stimulus/vaccination rollout alongside updated/upgraded(?) ‘Dot Plot’, which are the quarterly FOMC touch points.

Admittedly, with US economic upturn on a much firmer footing, further reinforced by the $1.9trln fiscal stimulus set to be signed off, US GDP rebound is expected to be north of 6%. In turn, this begs whether upward revisions to Fed’s US growth/inflation outlook trigger questions of whether the “Dot Plot” will be upwardly biased, and to what degree.

That is however a second order risk given the Fed’s propensity to allow the economy to “run hot” in this recovery will err on the side of generosity; at least at this point.

Instead, reference, if not response, to UST market upheaval will be what’s under utmost scrutiny for a meeting where no action is expected. Especially amid lack of clarity on the Fed’s proclivity; ranging from some degree of concern (Brainard) to comfort with rising yields reflecting optimism (Powell).

Specifically, whether the Fed will demonstrate an inclination to tame excessive UST yield upside volatility; even if it does not unveil new policy tool options or expand/extend facilities. Not unlike how the ECB pushed back against bond market utility; flagging faster bond purchases to quell recent upswing in long-end yields.

To frame another way, whether the Fed does an ECB or not may be this FOMC’s focal point.

In comparison to the ECB’s activism, there may be greater sensitivity to an absence soothsaying on yields. That is to say, upswing in UST yields and attendant USD volatility and asset markets, is a bigger risk if the Fed is perceived to take a benign view on rising yields.

Source: Mizuho Bank Ltd