Investors eye FOMC as FTSE turns choppy

The FTSE 100 turned choppy on Tuesday as Investor eyes became firmly focused on the FOMC decision tomorrow night, which is expected to see the US Federal Reserve announce plans to taper QE to the tune of $10bn per month.

The FOMC decision comes after the close of trading in London tomorrow so traders have already started to position themselves ahead of this announcement. The rally yesterday enabled traders to lock in profits at higher levels and downsize some risk ahead of the FOMC which could prove volatile, particularly if there are any surprises. As such, what we have started to see today is traders adding a defensive edge to their portfolios. This means we have seen selling in financial stocks and some flows into typical defensive stock sectors such as pharmaceuticals and tobacco stocks.

As a result, trading today was particularly choppy with the FTSE 100 losing 52pts to close at 6570 with losses escalating in the final hour of trading, emphasising the attitude of investors with the FOMC decision looming.

Financial stocks were the biggest drag on the UK index with Lloyds’ shares falling over 3% after a strong run and confirmation of the plans to sell part of the government’s stake in the UK bank. Pricing in Lloyds’ shares today have very much been an example of a ‘buy the rumour and sell the fact’ scenario.

It is important not to underestimate the importance of tomorrows FOMC decision and the tone used by Bernanke to communicate the likely progression of tapering in the medium term. The FOMC decision tomorrow will set the tone for risk appetite in the next few months and have a large bearing on how equity markets trade going into the year-end.

Onto the FOMC

The market is expecting the Federal Reserve to taper monthly purchases from $85bn to $75bn. There had been expectations last month that the size tapered could be as much as $15bn to $20bn though recent weaker than expected US jobs data has softened expectations to the tune of $10bn.

Back in the Fed’s June statement, they confirmed the potential for the Fed to start tapering asset purchases at some point this year if the recovery in employment continues towards the Fed targets. Of course, speculation had been in the markets for months beforehand that the Fed was beginning to change the way it thinks towards accommodative monetary policy. This has given the market ample time to adjust itself and digest the potential for the Fed to taper asset purchases. In this sense, a confirmation tomorrow that the Fed are tapering should not be a surprise.

The surprise would of course be if the Fed decides not to taper. The market has highlighted Septembers FOMC as THE date tapering will begin. It also comes conveniently with a press conference post-decision which allows Bernanke to explain his rationale to the markets and communicate how the size of tapering might progress in the future and any data thresholds that might dictate an alteration to the size of tapering. The scene is therefore set.

A decision not to taper may in the short term lift equity markets and pressurise the US dollar but in the longer term, it would raise many more questions and uncertainty in monetary policy. Will the Fed wait for the new Chairman to arrive before changing tact on policy? Has the economic recovery started to slowdown? What has the Fed seen that the markets have not?

Of course, the Fed could go the other way and aggressively taper to the tune of $20bn-$25bn per month, which would be more than the market expects and this could show the Fed are becoming more hawkish. This would likely bring the idea of rate hikes closer than the market is pricing in.

And so all eyes to the FOMC on Wednesday evening.