FOMC Meeting Preview Three Key Themes to Watch

Matt Weller
By :  ,  Head of Market Research

Ironically, as central banks across the globe have become more relevant than ever to the smooth functioning and valuation of financial markets, their scheduled monetary policy meetings have declined in terms of market significance. Put simply, central banks like the Federal Reserve have been introducing new measures and policies on an “as needed” basis, rather than waiting weeks for their next monetary policy meeting.

We’ve seen this exact dynamic play out already this week, with the Fed opting to expand its “Main Street” lending program yesterday, a mere two days before its regularly scheduled meeting, in an effort to support small- and mid-sized businesses as soon as possible. With interest rates already pinned to 0.0% and the Fed steadfastly refusing to entertain negative rates, traders should get accustomed to the central bank relying on non-traditional monetary policy tools for the foreseeable future.

When it comes to this week’s meeting, traders should focus on three key themes:

1)     Economic Projections

After forgoing quarterly projections in March given the elevated uncertainty, all indications suggest that the Fed will update its economic outlook this time around. While there will no doubt be a wider-than-usual range of uncertainty around all the projections, traders will key in on forecasts for economic growth, inflation, and of course, interest rates (the infamous “dot plot”).

In recent weeks, other central banks have upgraded their predictions for economic growth from the highly pessimistic outlooks given in March and April, but there’s no denying that Q2 is likely to be the worst economic contraction since at least the Great Depression; of note, the Atlanta Fed’s GDPNow forecast currently projects a staggering -54% annualized decline in Q2. Nonetheless, forward-looking traders will be more interested in the Fed’s projections for the (presumed) recovery in the second half of the year.

Finally, readers should also keep a close eye on the “dot plot” of interest rate expectations. The median central banker is likely to project interest rates remaining at 0.0% through 2022, but any dispersion (say, above 0.5% or into negative territory) could provide a hint of which way some of the fringe central bankers are leaning.

2)     Potential for Yield Curve Control (YCC)

Over the weekend, the Wall Street Journal reported that the Fed was “thinking hard about” yield curve control. In this type of program, the central bank would take measures to ensure certain longer-term interest rates do not rise sharply. Traditionally, central banks have their biggest influence on short-term interest rates, but Powell and Company could be looking at ways to influence longer maturities as the 10yr-2yr treasury spread just hit its highest levels since early 2018, despite the weak economy.

3)     Any Hints About Reining in Easing Measures

Finally, and perhaps most importantly, traders will watch for indications that the FOMC could rein in some of its stimulus measures in the coming weeks. The optics of the worst unemployment rate in a century combined with stock markets near record highs has led to public skepticism of the Fed’s independence (see the popular “Money printer go BRRRRRR!” meme as an example). Though each individual action the central bank has taken over the last few months was justifiable at the time, it’s led to a confusing cacophony of opaque stimulus programs including CPFF, PDCF, MMFLF, PMCCF, SMCCF, TALF, PPPLF and MLP. With less than five months to go ahead of the US election, Chairman Powell could prioritize pulling back stimulus to reinforce the Fed’s independence from political influence.

Source: GAIN Capital

Potential Market Reaction

Of course, all the above background information is useful to traders only insofar as it impacts financial markets. In that vein, if Chairman Powell leaves the door open to negative interest rates or intimates that the Fed still has plenty of ammo to stimulate the economy, US stock indices could extend their gains toward record highs, with the US dollar as a potential casuality. On the other hand, any discussion around reining in stimulus could prompt exuberant equity traders to reconsider the dour underlying economic situation. This scenario could lead to a pullback in US stocks and support the beaten-down greenback.

Related tags: Powell Fed FOMC DXY

Open an account today

Experience award-winning platforms with fast and secure execution.

Web Trader platform

Our sophisticated web-based platform is packed with features.
Economic Calendar