Global markets have been on edge since comments by Federal Reserve chairman Ben Bernanke last month, who suggested that if data improves QE tapering - a reduction in the rate at which the Fed's balance sheet is expanded - may begin. At present the Fed is buying up to $85bn in bonds each month.
Tonight he has a chance to calm those jitters, despite the Fed being near neither of its two targets (its unemployment target rate is 6.5 per cent and inflation target is 2.0 per cent). We have a round-up of what Fed watchers think could happen at 19.00:
So sensitive to the notion of QE's wind-up have markets become that having predicted a definitive timeframe for policy withdrawal by the Committee, the FT’s Economics Editor, via a tweet, had to implore the market to calm down after the Dow fell by 100 points on the article’s publication. Last week, noted Fed watcher Jon Hilsenrath wrote something similar but he too commented in a more recent note that Ben Bernanke would be obliged to emphasise the Fed’s measured approach in any tightening of policy. In as far as this implies the significance of the FOMC statement will be a matter of semantics, we could not agree more.
Michael Gapen, Barclays (link)
Whether the chairman succeeds in convincing markets that tapering is conditional on incoming data as opposed to a foregone conclusion, and that a willingness to taper should be separated from the remaining components of the exit strategy remains an open question. Markets will likely continue to view any move to withdraw policy as the first step of many and, as a result, volatility is likely to remain elevated as the market balances incoming data with Fed communications about its policy stance. What seems more clear to us, however, is that the Fed will seek to keep its options open. Should the outlook improve as the Fed expects, then it may continue to lay the groundwork for a tapering of purchases at upcoming FOMC meetings. However, should the data evolve more in line with our forecast, then we see the Fed as refraining from tapering until Q1 14.
Jason Gaywood, HiFX
Dealers thinking on this, however, is that any tightening of policy or ‘removal of life support’ would likely stifle any recent improvement in economic tone. As a result, bond markets, equities and the dollar remain vulnerable to any indication that the current monthly $85 billion bond buying programme is to be slowed or even halted. To highlight this, in the four day run up to the monthly release of US Employment data, we witnessed a 4.5 per cent move against the greenback from 1.5000 to almost 1.5700 in GBPUSD. This represented the biggest intra-week move for well over a year as dealers trimmed their USD long positions.
Ishaq Siddiqi, ETX Capital
Investors this week have scaled back expectations of an immediate unwinding of stimulus by the Fed, hopeful that the patchy run of data from the US economy will prevent a reduction in asset purchases in the near term. Traders are hopeful the Fed will shed some light on a timeframe of reducing the pace of QE and downplay the markets’ over-reaction since May 22.
Ashraf Laidi, City Index
The market reaction function was and remains generally the same: a binary set of interpretations, implying more Fed stimulus, or maintaining the status quo. The latter would mean a stronger US dollar, falling European and commodity currencies and weak global equity indices. More Fed stimulus would imply the opposite. This used to be called risk-on, risk-off, now it is referred to as taper-on, taper-off.
When all said and done, we expect the Fed to maintain its $85 bn monthly purchases unchanged into mid Q1 2014, and the ECB to slash interest rates to negative levels by year-end. This may imply a neutral-to-strong US dollar, but with a higher confidence level play in selling the yen against both USD and EUR.
In recent weeks, several FOMC participants indicated that it is considering reducing the pace of purchases soon. We do not expect the FOMC to announce a reduction in its pace of purchases at its June meeting and believe this is more likely to come at the September meeting. In the FOMC statement to be released at 2:00pm EDT, we expect the FOMC to note that the outlook for the labor market is improving and downside risks for the economy are diminishing, and expect it to reiterate that it is prepared to increase or decrease the pace of purchases as appropriate.
Our base case expectation is that the Fed will manage to “thread the needle” and that we end the week with a better backdrop for risk assets as US yields stabilize around current levels or moderately higher. If this is the case, we expect to see interest to rebuild USD long positions vs. the low yield G10 currencies. The risk scenario is that bond market volatility picks up again, exacerbating the exit from USD long positions that we have seen over the past two weeks.
The message that the Fed is thinking about scaling back QE before too long has been received loud and clear. What markets now want to know is “exactly how is this likely to proceed?”, and until more clarity on that is forthcoming, markets are likely to remain jittery.
Pragmatic Capitalism (link)
- The media will spend the day tirelessly debating what the Fed will say.
- The markets will all overreact to any little report about anything leading up to the official statement.
- The Fed will release a statement that changes a few dozen words (and says the same basic thing as the past few statements), the media will publish comparisons overanalyzing this statement relative to past statements and markets will overreact and read into every little meaningless change.
- Ultimately, the statement will actually say nothing of any significance and the day will be mostly a big waste of time and breath.