FOMC Preview And Likely Market Reaction

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FOMC Preview And Likely Market Reaction
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With the exception of a few, a growing number of central banks in major economies are scrambling to reverse some, if not all, of the ultra-accommodative policy enacted to combat the impact of the pandemic.

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Today, it is the US Federal Reserve’s turn to make its intensions clear on the future path of interest rates and, more to the point, its vast quantitative easing programme.

The question is not if but how much. Economists are mostly expecting tapering to be in the region of $15 billion a month, of which 2/3 would be in treasuries and the remaining 1/3 in mortgage-backed securities.

Let’s explore what different scenarios might mean for the markets.

Scenario 1: Fed Tapers $20-$30bn Per Month

Anything north of $15 billion would be deemed hawkish, especially if it is around the upper end of the range of analyst expectation i.e. circa $30 billion. A larger reduction in QE would probably lead to further hawkish market bets as it would bring forward expectations for the start of rate rises. In this scenario, we should see a big rally for the dollar, especially against the euro, given the ECB’s dovish stance. The EUR/USD could easily break 1.1500 and make a move towards 1.1000 in the days ahead. We would imagine US bond yields would spike and this in turn would weigh heavily on gold, sending the precious metal back down to $1700. Technology stocks, which carry lower yields, could also come under pressure as some yield-seeking investors find better value in fixed income provided by government debt than overvalued equities.

Scenario 2: Fed Maintains Status Quo Or Reduces QE Marginally

Conversely, if the Fed refuses to taper QE, or does so by only $5 to $10 billion per month, this would come as major surprise and probably cause the dollar to slump and trigger a relief rally for gold and silver. The yellow metal would likely reach for $1900 in the next few days. Watch out for a big rally in commodity dollars and emerging market currencies. Stock markets should also remain buoyant as such a decision would keep the goldilocks scenario more or less intact.

Scenario 3: Fed Tapers By $15bn Per Month

If the Fed meets expectations and tapers QE by $15 billion per month, the reaction of the markets will not be straight forward. This outcome should be mostly priced in, although some investors are undoubtedly waiting for some sort of confirmation. Thus, it is likely we may see an initial spike in the dollar — and yields — if the FOMC confirms market expectations by tapering its asset purchases programme by $15 billion. Whether that potential spike would then turn into a full-on rally, or gets immediately sold, would depend on the Fed’s wider views on inflation and the economy, and in turn, on interest rates outlook. We will have to rely on the words the Fed will use in its policy statement and the remarks chairman Jerome Powell will make at the press conference, as the dot plots will not be updated until the next meeting in December. Overall, we feel the Fed will once again insist that the end of tapering, likely to be at some point in the middle of 2022, will not necessarily mean rates will have to rise thereafter. The market is currently pricing in two rate hikes, with the first to come in June. Whether or not the Fed shed some light on the potential lift off time remains to be seen. But we may get a better idea on 15 December, when FOMC’s projections are released.

Article By Victor Argonov, senior analyst at international WealthTech, EXANTE

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