Wed, Dec 07, 2022 @ 00:28 GMT
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FOMC Meeting Preview: Is There Still a “Fed Put”?

Traders expect this week’s Fed meeting to be the proverbial “calm before the storm” of aggressive Fed tightening throughout the rest of the year – see what the possibilities are!

On the face, this week’s FOMC meeting should be a non-event. After all, Fed Chairman Jerome Powell laid out the central bank’s timetable in unusually clear terms at his Senate confirmation hearing earlier this month, stating “As we move through this year … if things develop as expected, we’ll be normalizing policy, meaning we’re going to end our asset purchases in March, meaning we’ll be raising rates over the course of the year… At some point perhaps later this year we will start to allow the balance sheet to run off, and that’s just the road to normalizing policy.”

Not surprisingly, the market has priced these comments and others into its outlook, with fed funds futures traders expecting just about a 5% chance of a rate hike this week, but a full four interest rate increases by the end of the year, with an outside shot at five or six. In other words, traders expect this week’s Fed meeting to be the proverbial “calm before the storm” of aggressive Fed tightening throughout the rest of the year.

Will the Fed end QE early?

From a purely macroeconomic perspective, the central bank is arguably already behind the curve; after all, the unemployment rate is below 4% and inflation is running at multi-decade highs above 7%. Against that backdrop, why is the Fed still buying assets through its Quantitative Easing (QE) program at all, even if it is tapering those purchases fairly aggressively? Indeed, in that same confirmation hearing, Powell already admitted that the Fed is “…mindful the balance sheet is $9 trillion. It’s far above where it needs to be.”

While not our base case scenario, there’s absolutely a risk that the central bank’s views have evolved in recent weeks and that Jerome Powell and company opt to end all asset purchases immediately, rather than waiting until March. In that case, we could see a kneejerk reaction lower in risk assets like higher-yielding currencies and indices while safe haven assets like bonds and the US dollar could catch a bid.

Where is the “Fed put”?

The “Fed put” refers to the tendency of the US central bank to ease monetary policy (or push back the timeline for tightening policy) in response to falling stock markets. While far from official, many investors believe that the Fed has an informal third mandate to ensure that stocks don’t fall too sharply due to monetary policy decisions.

However, in contrast to the current environment, many of the historical occasions when the Fed put reared its head coincided with fears that the US economy would slip into recession; instead, the predominant concern now is that the Fed will have to raise interest rates aggressively in response to inflation readings, perhaps slowing growth in the distant future. In other words, the Fed is likely not worried about an imminent recession, so the potential “Fed put” may be at a much lower levels in major indexes than we’re currently seeing, the ongoing correction notwithstanding.

What to expect from the Fed

Considering the above, the most likely scenario is that the Fed “sticks to the script,” leaving interest rates and the taper timeline unchanged. With some traders undoubtedly hoping that Chairman Powell will see stocks struggling and ride to the rescue with dovish comments, a steady-as-she-goes outcome from Wednesday’s monetary policy meeting could lead to another leg lower in risk-sensitive assets like commodity currencies and stocks. That said, any hints of delay or hesitancy on future interest rate increases could help support beaten-down risk assets, whereas an early end to QE could exacerbate the recent selloff.

Either way, traders will be hanging on every word from Fed Chairman Powell and the rest of the FOMC this Wednesday!

Forex.com
Forex.com
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