Stocks Surge as Fed Blink on Rates

As promised, today’s eagerly awaited Federal Reserve policy announcement resulted in serious fireworks in the financial markets. The takeaway: It was a buy everything day thanks to a smash lower in the U.S. dollar (that accelerated after the cash close) after the Fed struck a dovish note.

In response to a tightening in the labor market, the Fed set the stage for rate hikes potentially as soon as June by removing the “patient” language from its statement; but it also acknowledged recent economic weakening and softness in inflation (caused by falling energy prices and a rising dollar) by dropping its “dot plot” estimate of individual interest rate projections. That’s what caused the rip higher to recover from early session losses.

In the end, the Dow Jones Industrial Average gained 1.3%, the S&P 500 gained 1.2%, the Nasdaq gained 0.9%, and the Russell 2000 gained 0.8% to push to a new all-time high. The Dow traded in a 400 point range before closing above the 18,000 level.

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The Fed statement itself was largely boilerplate, noting further improvement in the labor market and reasonable confidence that inflation would move back to the Fed’s 2% target. The bigger story was what happened with the Summary of Economic Projections, or dot plot. Fed policymakers dramatically cut the median estimate of where rates will be at the end of the year from 1.2% to 0.6%.

Translation: The Fed is only looking for two rate hikes this year from four back in December.

Moreover, the end-2016 estimate was cut to 1.9% from 2.5% prior and the end-2017 was cut to 3.1% from 3.7%.

In addition to cuts to its 2015 GDP growth forecast (a range of 2.3-2.7% from 2.6-3.0%), headline inflation forecast (0.6-0.8% vs. 1.0-1.6%), and “full” employment rate (5.0-5.2% from 5.2-5.5%), this suggests the Fed is suddenly looking a lot less hawkish on monetary policy for the rest of the year.

The motivation for the change has a few moving parts.

For one, severe winter weather and a run of disappointing economic data has pushed down the Atlanta Fed’s GDPNow real-time estimate of Q1 growth to just 0.3%.

Two, the 25% gain in the dollar since last summer — encouraged by the relative strength of the U.S. economy compared to Asia and Europe and new monetary policy stimulus measures by foreign central banks — has had a chilling effect on inflation and export growth. The Fed, by acting dovish, leaned against this rise. There is a risk that foreign central bank respond (the Swedes cut interest rates deeper into negative territory this morning), risking talk of a currency war.

And three, there has for months been a disconnect between the Fed’s old interest-rate projections (four rate hikes for a 1% increase) and the market’s projections based on futures market pricing (one rate hike toward the end of the year). The Fed blinked first, moving its dot plot down closer to where traders were.

For a market that’s extremely dependent on the flow of cheap money from the Fed, this was like manna falling from the sky. Asset prices reacted accordingly with stocks, bonds, foreign currencies, precious metals and industrial commodities all rocketing higher.

The question now is whether the gains will stick or whether they will be reversed in the near term. The all feels very similar to the surprise market surge back in September 2013 as the Fed — to the surprise of pretty much everyone — held off on starting the tapering of its now-ended QE3 bond purchase program.

The Fed surprise capped a multiweek rise for stocks after which the Dow slid nearly 6%.

The plunge in the dollar after the close could be the start of a bout of intense currency market volatility — something that won’t sit well for hedge funds engaged in popular currency carry trades.

I flattened my exposure heading into the Fed announcement, recommending Edge subscribers close their ProShares UltraShort Crude Oil (NYSEARCA:SCO) trade for a gain of 34.1% since added on March 9.

Anthony Mirhaydari is founder of the Edge and Edge Pro investment advisory newsletters.

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Article printed from InvestorPlace Media, https://investorplace.com/2015/03/federal-reserve-interest-rates-patient/.

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