The first FOMC meeting of the year will conclude today, when the Fed announces its latest policy decision and releases a statement. There will be no press conference from governor Yellen, and no change to the dot plot of interest rate expectations, these won’t be updated until March, instead the focus will be on the statement.
Key things to watch out for include:
The Fed’s overall economic assessment. We doubt that it will change too much, and expect the Fed to continue to reference the improvement in the labour market and the moderate economic expansion. However, we would note that there has been an increase in US economic data misses in recent days, including Q4 GDP and PCE inflation. However, we don’t think this is enough to worry the Fed at this stage.
When will the Fed next hike rates? The market expects the Fed to hike rates in June. Any sign that a rate hike could come sooner than this could trigger a sharp reversal in fortune for the dollar, and a violent reaction in US bond yields.
Any reaction to Trump’s first steps as President. In fairness, we don’t think that the Fed will wade into this debate, however, the statement may reference the fact that economic forecasting is tricky without clarity on Trump’s fiscal policy. If the Fed sounds like it is on hold until it gets more information about the future of the government’s spending plans, then this could be perceived as dovish and may weigh on the dollar, while boosting stocks.
The Fed’s balance sheet. Balance sheet normalisation is a hot topic at the moment, and the key question is when will the Fed unwind its QE programme. Without clarity on fiscal policy, the Fed could decide to maintain a large balance sheet for the long-term. Even if it does try to “normalise” its balance sheet, we would expect this to be a gradual process, in order not to spook financial markets. Overall, we don’t expect this topic to make it into the body of today’s statement, instead, it is worth watching the minutes from today’s meeting, which are released on 22nd February, in case there was a discussion about unwinding QE at this meeting.
Trump’s reaction: we don’t think that the President will stoop so low as to criticise the Fed, but if Wednesday’s statement does trigger a rally in the dollar then we will watch what President Trump and co. have to say. Anything that threatens the Fed’s independence is likely to cause major risk aversion in global financial markets.
It is also worth noting that new FOMC members will vote this year, and the make-up of the Fed will tilt slightly more to the dovish side. Thus, the bar to unwinding QE and a near-term rate hike remains high, at this stage.
Potential market opportunities:
The dollar has fallen sharply as we head into this meeting, thus, on balance, there is a slightly larger risk of a recovery on the back of today’s Fed announcement. For the dollar index, 100.00 is a key resistance level. If the dollar index remains below critical support at 99.60 – the 100-day sma – then a recovery could be harder to achieve. USD/JPY is also likely to be sensitive to the Fed decision, especially after the BOJ committed to maintain its monetary stimulus at its meeting earlier this week. Any sign that the Fed could hike rates before June, may trigger a large reversal in this pair, and 115.00 could come back into view.
On the stock market front, the S&P 500 and the Dow managed to claw back some losses before the market close on Tuesday, even though investors are jittery. We would point out that there is the chance that US stocks could recover on Wednesday, after the Russell 2000, a small cap index and also considered a lead market indicator, rallied more than 1% in yesterday’s session. If the Fed statement does sound more dovish than expected, then this could trigger a deeper recovery in the US stock market.