JPY Up, Commodity Currencies Down; Lagarde comments

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Rates as of 0500 GMT

Market Recap

The FX market is still spooked by the Feds change in tone.

One of the key points is that the Fed has changed its reaction function. It used to be that they would change policy in response to their forecasts for inflation and employment. The reason for operating that way is because monetary policy affects the economy with a lag of up to three quarters. They therefore have to aim at the target that they expect to see in three quarters. Of course, this way of operating has the flaw that their forecasts may be wrong, which they often are.

As Chair Powell and others have mentioned, they are no longer going to move in response to forecasts, but rather in response to actual data. Unfortunately, this policy has a flaw too what if they think the change in the economy is only temporary, as they do now? It seems from looking at the dot plot that the Committee members have remained true to their new policy. Even though they argue that the rise in inflation is only temporary which is a forecast their proposed policy setting has apparently been determined by the actual data.

The market seems to be probing this contradiction and seeing just which side the Fed will ultimately come down on.

Note how 10year US Treasury yields and inflation expectations plunged following last weeks meeting. This suggests a change in view that the Fed will be more aggressive in fighting inflation than investors previously thought.

The move in the 30year bond was…

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