A more-dovish-than-anticipated Fed supports equities and government bonds
As expected, the Fed increased the target for the Federal funds rate by 25 bps to 0.75% - 1.00%. Moreover, its forecasts were little changed (US growth -- 2.1% for Q4:2017; core inflation -- 1.9% for Q4:2017; and the unemployment rate -- 4.5% for Q4:2017).
The Fed continues to foresee two more rate hikes by end-2017 (to 1.50%) followed by three hikes by end-2018 (to 2.25%) and three hikes by end-2019 (to 3.0%). Market expectations are far more dovish (see graph).
Changes to fiscal and trade policies by the new US administration could affect Fed policy. In this respect, President Trump’s mini-budget proposal for fiscal year 2018 (including amendments for fiscal year 2017) did not increase the deficit, with the proposed increase in spending for military, border and homeland security offset by cuts in other departments (especially the state department and the EPA). The complete budget document is expected in May 2017.
The G20 Communique dropped its reference to resistance to all forms of protectionism, reflecting the views of the new US administration.
To the relief of markets, in the Dutch elections, the extreme-right underperformed by a wide margin. Specifically, the center-right VVD party of incumbent PM Rutte garnered the most votes, gaining 33 seats (from 41) in the 150-seat parliament, while the (extreme-right) PVV party of Mr Wilders captured 20 seats (up from 15 previously).
As political uncertainty subsides and euro area growth momentum remains strong, the ECB policy could turn less dovish. Note that ECB Governing Council member Nowotny suggested that a rise in the deposit facility rate could happen before the termination of the asset purchase programme.
The more-dovish-than-expected tone of the Fed meeting statement and unchanged rate projections supported markets (MSCI World:+0.7% wow /+5.8% ytd). The EuroStoxx rose by 1.2%, while the S&P500 ended the week broadly flat (+0.8% on 15/03). EM equities overperformed (+2.9% in LC, +4.3% in USD terms wow) against the backdrop of a more benign Fed. EM currencies recorded the largest daily gain against the USD in one year on Wednesday (1.3%).
In fact, the US dollar weakened across the board, declining by 0.6% against the euro ($/1.074) and by 1.9% against the GBP ($/1.239). A slightly more hawkish statement by the Bank of England (the policy rate was maintained unchanged at 0.25%) was also GBP supportive, although we still see a low risk of a rate increase during the early stages of Brexit negotiations (PM May will trigger Article 50 on March 29).
Long-term government bond yields in the US declined by 7 bps wow to 2.50%, with real rates (currently: 48 bps) leading the decline (the breakeven inflation rate was unchanged at 202 bps). Long-term German Bund yields also declined, by 5 bps wow to 0.44%, albeit the 2-year bonds rose by 6 bps to -0.77%, due to higher expectations for a rate hike by the ECB before the termination of the asset purchases programme.