FOMC: Optimistic But Not Yet Hawkish

While all eyes were on the ruckus in the Middle East and a possible nuclear breakdown in Japan, markets largely overlooked the Fed’s FOMC statement released last Tuesday. Did traders miss out on a big announcement, or did the Fed just play the straddle card yet again?

Before the huge earthquake hit Japan last week and trouble in the Middle East started escalating, markets were at the edge of their seats, waiting to hear what Ben Bernanke and his posse had to say about the U.S. economy. While no change in interest rates was expected, a lot of factors came into play since the last FOMC statement that could have change the Fed’s tone about terminating or extending its QE2 program.

In one corner, analysts saw an improvement in the manufacturing and services sector of the U.S., as well as slight upticks in consumer spending and employment numbers. On the other hand, the surge in commodity prices weighed down on economic growth.

Now that the FOMC statement is done and over with, what did the Fed members have to say? Let’s start with the good stuff.

First and most notable is that, although we didn’t get a rate hike, the FOMC was more upbeat about economic recovery than before. According to the statement, the economy is “on firmer footing,” That is a pretty darn giddy remark considering that our central banking dudes and dudettes described the recovery as “disappointingly slow” in their last statement.

The improvement in the unemployment rate to 8.9% last February might have also been enough for the FOMC to note that the labor market is slowly improving. On top of that, the hotshots at the Fed also didn’t seem to be that worried about weakness in consumer spending anymore.

Naysayers had been waiting for them to say that “tight credit conditions” were still weighing down on the Americans’ swag for shopping. But there was no trace of pessimism about consumer spending in the statement. Boo yeah!

I wouldn’t be too excited about it if I were you though. You should know that the Fed’s words weren’t exactly all sugar, spice, and everything nice. Despite acknowledging improving conditions in the labor market, Big Ben and his buddies noted that the unemployment rate remains at a high level and that inflationary pressures are still on the down low as they expect the surge in oil and other commodities to be temporary.

So what’s the verdict on monetary policy?

Well, most economic gurus say that investors can breathe a sigh of relief as the FOMC statement could mean that QE3 is off the table and that the 600 billion USD asset purchasing program may end as scheduled in June. However, don’t hold your breath for an interest rate hike anytime soon, as it looks like the Fed will most likely take their sweet time before raising rates.

So yes, the FOMC statement was optimistic but not hawkish enough to send traders into a dollar frenzy. Just take a look at chart of EUR/USD. Even though we saw a massive wave of risk aversion drive the dollar higher against higher yielding assets, EUR/USD still managed to close higher on the day after the release of the FOMC report!

EUR/USD Daily Chart

It’ll probably take some time before the markets really start shifting their stance towards the dollar. After all, the recent bullish run of EUR/USD was due to pricing in the combination of the divergence in interest rate policies between the Fed and the ECB. With inflation plaguing the euro zone, and with the Fed continuing its pledge to keep rates low for an extended period, we may just see EUR/USD continue to climb up the charts!