Here’s What A Dovish Rate Hike Means For Some ETFs
Surprise, surprise… the FOMC raised rates in its March meeting, the markets were already pricing this in. In fact, according to the CME FedWatch Tool, heading into the meeting, there was at least a 90% probability that the Fed would raise rates by 25 bps, or 0.25%. However, traders saw this as more of a dovish rate hike. Consequently, according to the CME Group 30-Day Fed Fund futures prices, market participants are placing bets on the Fed leaving rates unchanged at its May meeting.
Source: CME Group
Dovish Rate Hike
The FOMC’s statement was dovish, despite raising rates. Now, here are the elements that were considered dovish: some Fed officials were in favor of keeping rates unchanged at the meeting; adding some new language on core inflation, which has been less than 2%; indicating inflation could increase above 2% just as long as the Fed does not see a consistent inflation spike.
In fact, the Fed dot plots were also considered dovish by some analysts and traders. Trader Jason Bond stated
“The markets reacted to the dovish rate hike as if they cut interest rates. Now the Fed projections were unchanged, and they were expecting three-quarter point rate hikes in 2017 and in 2018. However, some traders may have been expecting four or more rate hikes this year. That could be one of the reasons why some exchange-traded funds reacted the way they did.”
The rate hike was a hard read for some traders. In the Fed’s statement for its March meeting, it stated
"In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments.”
Now, here’s the more dovish part of the FOMC statement:
“The Committee will carefully monitor actual and expected inflation developments relative to its symmetric inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.”
That’s more or less the same ongoing story with the Fed. It’s playing the wait and see game, rather than taking a more proactive approach, despite raising rates in the meeting.
Markets React to Rate Hike
With this rate hike, we actually saw the U.S. dollar weaken, and the U.S. Dollar Index is nearing the 100 level now. However, the rate hike should actually cause the U.S. dollar to appreciate, but traders may be thinking that two additional rate hikes would not be enough to cause the U.S. dollar to appreciate significantly against other major currencies.
Additionally, we saw Treasury bond funds rise after the rate hike. The iShares 20+ Year Treasury Bond ETF (NYSEARCA: TLT) returned over 1% for the week ended on March 17, 2017. That said, traders were bullish on TLT, despite the 0.25% rate hike, which should have cause the ETF to fall due to the inverse relationship between bonds and rates.
Traders should continue to focus on comments made by Fed officials, and they should look for any clues in the FOMC’s next meeting. It seems as if the markets are shifting their focus back to the Fed now, which was not really the case when there were multiple Trump trades on the table.
Disclosure: The material appearing on this article is based on data and information from sources I believe to be accurate and reliable. However, the material is not guaranteed as to accuracy nor ...
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