Thoughts of a Fed policy turnaround scared markets

Former Fed chief and current US Treasurer Yellen sparked a violent sell-off in equity markets, noting that an interest rate hike may be needed to prevent the economy from overheating as Biden’s stimulus plan came into play.

A few hours later, Yellen clarified that she can’t push the independent Fed to a rate rise, doesn’t forecast hikes and expects rates to remain low for a long time.

However, the very thought of a Fed policy turnaround, albeit not from FOMC members, continues to hurt markets.

The markets perceive this “throw-in” and the subsequent pullback that a reversal is in sight at the highest policy level. Apparently, by mentioning the need for a rate hike to secure against overheating, the US Treasury chief looked to the distant future, probably several years ahead.

After all, under the forward guidance policy, one would expect 1) signals for the QE tapering, 2) the actual tapering and, only after some time, 3) the rate hike cycle starts.

In theory, an active rate hike would be a greater blow to growth stocks, which have already come under increased pressure in recent days. Much of the rise in their quotations over the past year has been due to the belief that historically low rates will sustain years of outpacing growth for high-tech companies looking to expand their businesses using easy money policies.

The Nasdaq100 lost more than 2.5% at one point yesterday and closed down 1.9%. Early in the day on Wednesday, the index had changed little in value, taking a breather searching for new meaningful drivers. Meanwhile, the Dow Jones managed to close Tuesday’s trading with a gain of 0.06%, reversing more than a 1% decline.

In the forex market, the Dollar got support, bringing EURUSD back below 1.2000 on increased speculation that hints of an imminent QE rollback will be forthcoming following Yellen’s warning.

In our view, the market’s reaction to these comments has the potential to support a corrective bounce of the Dollar after the decline in April. This will remove the accumulated short-term oversold from the Dollar but is unlikely to be a viable medium-term growth driver for the US currency. Today the markets will listen to FOMC members Evans, Rosengren and Meister’s speeches as well as the ADP private employment and non-manufacturing ISM reports, looking to see if the US economy is really in danger of overheating.

The FxPro Analyst Team