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Fed meeting in focus

By David Morrison  |  21/03/2018 10:50
”FOMC
This article considers the Fed's options and the importance of the FOMC's forecasts for future rate hikes

Monday’s sell-off

The major US stock indices posted modest gains yesterday but never came close to making back losses from the beginning of the week. Monday’s sharp sell-off may have done some technical damage, possibly indicating another shift in sentiment amongst investors. The Dow fell back into negative territory for the year while the S&P 500 slumped below both its 50 and 100-day simple moving averages. Yet the tech-heavy NASDAQ still looks remarkably resilient, despite suffering heavy losses after Facebook shares slumped.

Facebook falls sharply

The emerging scandal over Facebook’s “cavalier” approach to its users’ data has hurt the company, and may continue to do so for some time. It could also have a knock-on effect to the rest of the tech sector, and the FAANG stocks (Facebook, Amazon, Apple, Netflix and Google (Alphabet)) in particular. There are an increasing number of voices calling for them to be regulated, taxed more heavily, nationalised or broken up as these companies are increasingly scrutinised and found wanting. Certainly, there are few people left who take Google’s motto and injunction to “Do no harm” seriously anymore. This could be a problem for the wider market. The tech giants have been at the forefront of the equity market rally for years now, and make up a very large proportion of fund managers’ equity holdings.

Investors wary

Facebook’s tribulations are contributing to dip in overall market sentiment. Bear in mind, investors are already struggling to get a handle on what’s going on at the White House, not just because of the seemingly never-ending sackings, but also about the Mueller investigation and disquiet over moves at the very top of the FBI. On top of this we have Trump’s tariffs and the possibility of a trade war.

“Dot plot” in focus

But the more immediate concern for investors is the Federal Reserve meeting - Jerome Powell’s first as Chairman. The Fed will release its rate statement this evening along with the FOMC’s quarterly Summary of Economic Projections. According to the CME’s FedWatch Tool (which uses the fed funds futures to calculate odds on forthcoming rate hikes) there’s a 94% probability of a 25 basis-point rate rise, meaning that a rate hike should be fully priced in to markets. Consequently, investors will be paying far more attention to the FOMC’s quarterly Summary of Economic Projections, and the most important element of this is the “dot plot”. This gives a pictorial representation of each FOMC member’s (anonymous) forecast for future fed funds. Back in December most members anticipated three 25 basis-point rate hikes in 2018 and two in 2019. The question now is whether this will be revised upwards or not?

FOMC’s options

The trouble is that there are several possible permutations. To keep things simple, let’s consider the two “extreme” possibilities. Firstly, the FOMC forecast could be unchanged, that is three hikes this year and two next. This should be bullish for equities and precious metals, and negative for bond yields and the dollar. Secondly, there’s Goldman Sachs’ prediction of four hikes this year and next. This should see bond yields and the dollar soar while gold and stock markets should sell off sharply. This forecast is an outlier so would take investors by surprise – and not in a good way.

Middle path?

But there is a middle path where the FOMC keeps its options open with a slight hawkish bias. This would leave their 2018 forecast unchanged at three hikes, but raising next year’s prediction to three from two. This would make sense given that the Fed is currently reducing its balance sheet, and it still has room to move to a faster rate of tightening later in the year when it has more information on the effectiveness of current monetary policy. If this were to happen then Fed Chair Powell’s subsequent press conference will take on additional importance, particularly when it comes to the Q&A session.

Inflation expectations

There has been some speculation that the recent stock market pull-back could persuade FOMC members to temper their forecasts and appear less hawkish than anticipated. However, there’s little doubt that Fed Chairman Powell is less hung up on the stock market’s behaviour than his predecessors Janet Yellen and Ben Bernanke. Additionally, New York Fed President Bill Dudley recently opined that four 25 basis point rate hikes are “still gradual”. Investors will also look out for the FOMC’s inflation forecast. If this is revised up significantly then we could see the yield on the 10-year Treasury head back up to retest 3.00%. This could also put downside pressure in equities – in the short-term at least.
 
Any information, analysis, opinion, commentary or research-based material on this page is for information purposes only and is not, in any circumstances, intended to be an offer of, or solicitation for, a transaction in any financial instrument. No representation or warranty is given as to the accuracy or completeness of this information. Any person acting on it does so entirely at their own risk and GKFX accepts no responsibility for any adverse trading decisions. You should seek independent advice if you do not understand the associated risks.
 

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