The attention is turning to the Federal Reserve policy meeting and Fed Chair Jay Powell’s testimony later on at 19:00 and 19:30 BST, respectively. No one is expecting any changes to be announced in as far as monetary policy is concerned and there won’t be any updated projections (AKA “dot plots”) either. Instead, all the attention will be on hints of and discussions around tapering. Investors will be scrutinising the language used in the policy statement and the words offered up by Powell at the presser. The markets appeared calm ahead of the event. Stocks were rebounding after the sell-off on Tuesday; the US dollar was mixed, and the 10-year yields were up a little.
If you recall, the June FOMC meeting saw policymakers adjust upwards the dot plots as they signalled interest rates are coming sooner than they had previously envisaged. Since then, we have seen further improvement in US data, with core inflation rising to 4.5%, its highest level in 30 years, while the latest nonfarm jobs report came in at a good 850,000 and retail sales rose more than expected.
So, there has certainly been progress in the economy, but the key question remains as to whether the Fed thinks “substantial further progress” is still not achieved. The Fed may err on the side of caution as on back of fading fiscal support and renewed concerns over rising variants of COVID, which could lead to a sharper slowdown in economic activity. Therefore, the Fed may decide against providing the timeline for tapering QE at this meeting. If so, this should keep the goldilocks scenario intact for stocks but provide some headwinds for the dollar.
Indeed, this is how the markets probably feel the Fed will play its cards today, for otherwise the major indices would not be sitting at or near record highs and real yields wouldn’t be as low as they have. The bigger risk therefore is if the Fed provides a hawkish surprise and catch the markets off guard. Otherwise, don’t expect to see too significant a reaction on this occasion.
Still, even if Powell continues with his transitory rhetoric, it is important to take into account market expectations as per above. Also, there is still the risk that inflation concerns could come back to haunt the markets later this week, if incoming data once again show price pressures are rising more than expected. We have the Fed’s favourite inflation gauge - the PCE core price index - on Friday, the same day when we will have the latest Eurozone CPI estimate. German CPI, meanwhile, is due on Thursday.
Ahead of the Fed meeting, the Dollar Index was testing its bearish trend line and 21-day exponential moving average with no clear directional bias. A daily close below 92.00 would be bearish, while a potential move north of April’s high at 93.43ish would create a higher high for the index in a bullish development.
Source: ThinkMarkets and TradingView.com