FOMC preview – will sleepy markets be given a Fed wake-up call?

On Wednesday at 19:00 BST (Thursday 04:00 AEST), Chair Jay Powell is set to deliver a press conference after the FOMC meeting. However, as the US (and global economy) heals, so too does the need to slowly normalise policy. 

Betting against a dovish Fed is always hard, especially when millions of Americans who lost jobs through the pandemic are still without work. However, given current expectations and a market short of USD’s, could the FOMC meeting indeed prove to be a volatility event for traders?

Key focal points and possible market reaction 

While there's much the market could focus on, here's five core factors that the market will be most sensitive to: 

✔️ Taper talk. With the market obsessed with the timeline for reducing (tapering) the pace of its asset purchase program (QE) from its current rate of $120b pm bond-buying (QE) program – how the Fed see the evolution of tapering will be a key focus for market participants. 

• Trader thoughts – We expect some strong probing by the media in Chair Powells’ press conference on the subject. While Powell will tread carefully, I expect that the Fed is warming to a more open discussion about tapering, to be formally announced in the September meeting. Expect Powell to offset with dovish talk that there's still someway to go until they “substantial progress” in the economy. Any view that cements a formal announcement in September should be modestly USD bullish, but the risks are symmetrical as Powell will be keen to not hurt financial conditions. 

✔️ Dots to show a hike in 2023. In March we saw 7 (of 18 Fed voting members) voting for a hike in 2023. Can we see another two members switching calls to pencil in a hike in 2023, resulting in the median projection moving to a hike? 

• Trader thoughts – This is perhaps the key point of contention for traders and a close call, but on balance I feel we should see two members changing calls, resulting in a 9/9 split and the median projection lifting for a hike in 2023. This would be a clear USD positive and should weigh on gold and equities. 

✔️ 2022 core PCE inflation revisions? We should see a sizeable revision to their 2021 projection of core PCE (personal consumption expenditures) from 2.2% to 2.8% (perhaps even +3%). However, more importantly will be whether estimates for 2022 core PCE is revised higher or lower from 2% and to what extent? 

• Trader thoughts – Any revisions for 2022 core PCE inflation higher than 2.1% would be bullish for the USD, while revisions lower than 2% would be a USD negative. The risks are slightly skewed to a USD positive outcome. 

✔️ It’s all about the labour market. Given the US labour market is the Fed’s priority when setting policy, employment trends will be discussed at length in Jay Powell’s press conference – subsequently, any changes to the Fed’s forecasts for the 2021 or 2022 unemployment rate could move markets. The current forecast stands at 4.5% and 3.9% respectively. 

• Trader thoughts – The market expects to see the estimate for the 2021 unemployment rate revised modestly higher, while the 2022 estimate is expected to remain at 3.9%. The USD will be sensitive to revision to 2022, so if the unemployment rate is revised lower the USD should find buyers (and vice versa). 

❌ A hike in short-term rates? Will there be a technical 5 basis point (bp) adjustment higher to IORB (Interest on reserve balances) and the overnight RRP rate (reverse repo program)? A complicated consideration, but these guide short-term US interest rates which, in tuns, has a dramatic effect on the USD. 

• Trader thoughts – I’d argue a hike here is priced at about 35%-40%, so no change to these settings shouldn’t move markets too greatly. A 5bp hike would see US short-term interest rates rising and in turn putting a bid into the USD (Gold and Tech negative).

What’s the trade?

With the market running a short USD position and leveraged funds having pared back shorts in US Treasuries it feels like the risk at the FOMC is slightly skewed to a stronger USD, which could weigh on Tech and Gold. Betting that the Fed will be hawkish (relative to expectations) is always tough, so the preference is to wait for price to push the trade. Here's a few levels I like:USDX – tactically bullish on a closing (daily) break above 90.50

USDCAD – Bullish on a firm close (daily) above 1.2150

USDJPY – always a clean plan of the FOMC meeting – bullish > 110.30, bearish <109.18

NAS100 – the index is trending higher – preference to stay long until price close < the 5-Day EMA

Gold – price has broken the March uptrend and a daily close below 1856 (4 June low) puts the 200-day MA in play. This could potential seek a target of 1816 and could turn bullish on a daily close above 1910.