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FOMC minutes in focus

By David Morrison  |  21/02/2018 11:47
This article looks ahead to the release of minutes from the last FOMC meeting and what they could mean for investors
Equities under pressure

All the major US stock indices closed lower on Tuesday with the biggest declines coming in the Dow, S&P 500 and Russell 2000. Disappointing earnings and a sharp slowdown in online sales from Wal-Mart were fingered as the initial trigger for the sell-off. But it wasn’t long before investors rushed back in to “buy the dip” sending the majors sharply higher and the S&P 500 back into positive territory soon after the European close. However, the rally faded later in the evening taking the S&P 500 back below both its 21 and 50-day simple moving averages.

 Bond yields elevated

Last night’s sell-off weighed on European equities this morning while US stock index futures struggled to stay in positive territory. This was despite a modest back-up in US Treasury yields which has seen the 10-year dip back below 2.90%. Nevertheless, bond yields remain elevated and should continue to dampen buying enthusiasm for as long as the 10-year yield remains above 2.80% and within striking distance of 3.00%.

FOMC minutes – hawks ascending

Now all eyes are on the release of minutes from the Fed’s January FOMC meeting. The market has just about fully priced in the likelihood of three 25 basis point rate hikes in 2018. This brings it in line with the FOMC’s forecast taken from the committee’s Summary of Economic Projections in December last year. However, the recent spike in inflation as measured by the latest CPI and Average Hourly Earnings releases has begun to impact expectations going forward. There is growing feeling that the Fed may be in danger of falling behind the curve when it comes to tightening monetary policy. Therefore, there’s growing speculation that tonight’s minutes may indicate a shift towards raising rates by a full percentage point this year – something yet to be priced in by markets. If so, this would come on top of the plan to tighten monetary policy by mechanistically reducing the US central bank’s balance sheet. This would be consistent with the Fed’s mandate of maintaining price stability at a time when the Trump administration is providing dollops of fiscal stimulus in the form of tax cuts, regulatory reform and proposed infrastructure spending. This is all potentially inflationary, not least as it is unfunded so adds to the deficit and so weighs on the dollar.

Possible market reaction

The big question now is what effect would a move towards four 25 basis point rate hikes have on markets? After all, it has been discussed widely so shouldn’t be considered a surprise. However, it hasn’t been priced in and it looks likely to raise speculation that the Fed is now seriously worried about inflation breaking to the upside, after years of fretting about deflation. This could lead the Fed to raise the inflation target above 2% temporarily - something which would be particularly good for gold and bad for the dollar. 

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