Dollar soars as Fed shuts QE3 door

The dollar was the biggest winner, stocks pared earlier losses and yields fell as the Fed concluded its 3^rd quantitative easing (QE3) by announcing the tapering of the remaining $15bn of asset purchases it began in September 2012. Despite re-affirming interest rates would remain exceptionally low for a “considerable time”, it cautioned that rate hikes could “likely to occur sooner” if information on inflation and employment indicated “faster progress” towards the Fed’s goals.

One-Two upgrade

The Fed produced a clear upgrade of its view on labour markets by stating that “underutilization” was “gradually diminishing”, while adding that “likelihood of inflation running persistently below 2% has diminished somewhat since early this year”. These changes with regards to inflation and unemployment were the most striking elements of the Fed statement, highlighting its hawkishness and positivity for the US dollar, thereby offsetting the dovish effect of keeping “considerable time” guidance intact.

Even Plosser was satisfied

The upgrade on employment and waning of deflationary worries was so stark and sufficient to the extent that arch hawk Philadelphia Fed’s Charles Plosser voted in favour of keeping the “considerable time” guidance. Recall that in the September meeting, Plosser objected to the “considerable time” guidance “because such language is time dependent and does not reflect the considerable economic progress that has been made toward the Committee’s goals”. The fact that Plosser dropped his hawkish dissent highlights internal shift of the discussions shaping the new Fed statement.

Dollar, stocks & yields reaction suggest measured hawkishness

While dollar rallies resulting from Fed statements are usually associated with falling stocks, today’s FX/Equities reaction reflected a more market-friendly slant towards hawkishness. While the upgraded view on labour markets and diminishing worries of disinflation boosted the greenback, the maintaining of “considerable time” guidance on low interest rates avoided any bringing forward of rate hike expectations, which helped weigh on bond yields (10yr yield – 5bps) and pared earlier pullback in stocks.