Markets caught off-guard by Fed comments

Markets were caught off-guard by some of the rhetoric from the FOMC projections and comments from FOMC Chair Yellen in the accompanying press conference. On balance it would suggest the FOMC believes rate hikes may come a little earlier than previously projected, although this is of course data dependant.  Furthermore, while long bonds have sold off, yields still remain very low.

There was a lot of focus on the "dots" in the projections, which signify the level of the Fed Funds rate by year end for the next few years.  These showed some upward drift compared to the last meeting.  Ive been representing this for sometime, although more as blobs than dots, so we can compare more than just one meeting to the other.

As the chart above shows, there has been a slight revision to levels in 2015 upwards, with more participants seeing rates at ~1% by the end of the year. That would imply the first move in rates would be earlier than previously envisaged by more Fed members.

Chair Yellen tried to hose down the importance of this change, although given the Fed chooses to publish it and it represents the views of FOMC members, it is not unimportant.  But it is perhaps not as important as other projections which shape the path for policy.

On this front little has changed.  GDP for 2014 has been revised a little lower, although mostly due to weather in Q1 rather than anything else.  Forecasts for 2015 currently stand at around 3%.

Significantly, inflation forecasts remain unchanged, with core PCE forecast to remain 2% over the projection horizon.

Unemployment rate expectations have been revised lower, although the quantitative threshold on this has been dropped from forward guidance.  Markets didn't react too much to this.

What gained greater attention was the comment from Chair Yellen that "a considerable period of time" was perhaps something like 6 months, depending on data.  This, along with the projections, pushed markets to think rate hikes might come a little earlier than was previously priced in.  The chart on the left shows the movement in Fed Fund futures, which repriced ~25bps from levels a month ago for the end of 2015.

A little perspective is needed here given the amount of noise surrounding these announcements. Firstly, rate hike expectations are way below where they were in September, when the Fed started to talk about winding down QE.  The fact they have started this process and rates remain low suggest markets moved quickly when it was clear they were getting ahead of themselves. Fed speeches in the next few months are likely to have the same affect, where they are likely to reinforce the tone from the official statement, where "The change in the Committee's guidance does not indicate any change in the Committee's policy intentions as set forth in its recent statements."

Its also worth noting that while the long end of the curve sold off, at 2.75, 10 year Treasuries are still someway below their recent highs.  This will mean that while the Fed will perhaps want to massage the markets through upcoming speeches, it won't be panicked.

What does this mean for commodities?

A change in Fed thinking is most important for precious metals and gold in particular, which sold off today.  But this doesn't represent a seachange in the view, with the guidance around the timing of the first rate hike likely to be much more explicit when the Fed is confident when it will occur.

For other metals and bulks, this is really a side show to developments in China.  Demand in the rest of the world is still a positive, although that has faded with slower leading indicators.  But clearly there is huge uncertainty about Chinese demand, much more so than there is around Fed policy.