FYI | Oct 30 2013
By Kathleen Brooks, Research Director UK EMEA, FOREX.com
After the September meeting when the market seemed so sure that the Fed would start tapering, October’s meeting is facing the same type of certainty from the market with the vast majority expecting the US central bank to remain on hold and firmly neutral. While we agree that the Fed is unlikely to start tapering or dramatically adjust policy at this meeting (after all, it still does not have a firm grip on the economy as delayed economic releases dribble out post the resolution of the US government shut down) we also think that this meeting has the potential to generate volatility in the markets and may not be as boring as some expect.
Let’s take a look at market moves since the September meeting, when the Fed surprisingly chose not to begin its tapering programme followed closely by the fiscal crisis in Washington.
• The 10-year US Treasury yield is down more than 20 basis points (this is a huge move for Treasuries).
• The US overnight index swap curve is currently expecting rates to rise in Q3 2015, significantly later than rate expectations back in September.
• The dollar index fell nearly 3%.
• The S&P 500 rose to fresh record highs over the last month
The fundamental data has supported the scaling back of US rate expectations, for example Citigroup’s economic surprises index has dropped consistently since the start of this month. However, after such profound moves in the market already, how much later can the market expect the Fed to delay rate hikes and QE tapering?
Could the Fed surprise the markets again?
Overall, the dovish news from the Fed could already be priced in, and the bigger risk could be a “hawkish” (or should I say less dovish) surprise from the Fed on Wednesday. So what would be considered dovish from the Fed statement tomorrow?
• Considerable worries about the economy and long-term economic damage from the on-going fiscal issues in the US, which have now been pushed out to late 2013/ early 2014.
• Recalibration of the Fed’s forward guidance including pushing back the unemployment rate threshold, potentially to 6%, currently it is 6.5%.
Why we think this is unlikely: while the fiscal tussles in Washington should not be ignored, we doubt that the Fed will be so downbeat on growth, especially considering the picture remains unclear due to the delayed data releases, thus the Fed may prefer to wait until the December meeting to give a firm judgment on the economy. Likewise, we think any change to the Fed’s forward guidance is unlikely at this juncture, especially as the Fed has already stated that it has a broad array of measures it uses beyond just the unemployment rate that will determine its pace of tapering and eventually tightening.
What we do think that the Fed could express in this statement is a desire to put pressure on the government to deal with the US’s fiscal problems in a timely manner and avoid more economic disruption next year. If the Fed bats the ball into the government’s court this could be interpreted as the Fed’s unwillingness to support the economy if government does not do its bit, which is a similar stance taken by the ECB and BOJ in recent years and months.
Not dovish enough
If the Fed does adopt this stance then it may not be dovish enough for a market hooked on liquidity. Thus a simple shift in Fed rhetoric that applies pressure on the US government to actually do its job could disrupt recent price action, boosting the dollar, pushing up Treasury yields and weighing on stock markets.
Market view
When it comes to US monetary policy it’s always worth looking at USDJPY. This cross has been trapped in a frustrating range between 97.40 – 98.40 – the 200-day sma on the downside and the Ichimoku cloud base and 50/100 day smas on the upside. A less dovish Fed could trigger USDJPY strength in the medium-term. A break above 98.40 resistance opens the way to the Ichimoku cloud top at 98.80. Above here is a bullish development that could see back towards 100.70 highs from early September.
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