The Fed “Unwinding” Is Upon Us, Worrying Some Market Observers

“We are long inflation breakevens and long in both developed and emerging market equities, alongside holding little exposure to the USA dollar as the pace of monetary normalisation will continue to be stronger outside the U.S. and could weigh further on the currency in the medium run”, Marciot says.

The Fed also reduced its outlook for inflation on Wednesday, cutting its expectation from 1.7 percent this year to 1.5 percent, and from 2 percent to 1.9 percent in 2018.

“Job gains have remained solid in recent months, and the unemployment rate has stayed low”, the Fed said in a statement. The VIX declined 3.9% to finish at 9.78, on a scale of 1-100 where readings below 20 normally point to complacency in the market.

The U.S. Federal Open Market Committee on September 20 said the Federal Reserve would start reducing its $4.5 trillion balance sheet in October.

Nicholas Wall, portfolio manager of the Old Mutual Strategic Absolute Return Bond fund, said the move should not derail the economy: “This was widely expected; the Fed had wanted to get the process of balance sheet reduction underway before its composition changes next year”.

The yen, often sought in times of geopolitical tensions, showed little reaction to U.S. President Donald Trump ordering new sanctions against North Korea on Thursday. This could be a very lively session for the Dollar, especially when considering how the FOMC will be updating its economic projections and providing its forecast for growth, inflation and interest rates.

Oil prices were higher.

The Standard & Poor’s 500 index fell 4 points, or 0.2 percent, to 2,502.

“If the Fed hints at a rate hike in December, the Nikkei will likely rise further helped by the dollar’s rise against the yen”.

Markets anticipated the balance sheet unwinding and have been quiet so far on Wednesday. The Dow gained 63.01 points, or 0.3 percent, to 22,331.35.

In other news from central banks, the Bank of Japan kept its monetary policy unchanged at its meeting overnight, although the BOJ did signal it may need to-somehow-expand its own stimulus measures in the near future.

Analysts all but surely expect the Fed will move on the key rate in December.

In response to the announcement, investors quickly piled into riskier assets as they took the Fed’s plan to be sufficiently hawkish. The central bank raised interest rates twice this year, in March and June respectively.

Benchmark 10-year notes were last up 5/32 in price to yield 2.26 percent, up from 2.24 percent before Wednesday’s Fed statement.

CURRENCIES: The dollar fell to 111.26 yen from 111.58 yen.