Its FOMC Day and for this reason currencies are consolidating in anticipation of the Federal Reserveâ€™s monetary policy announcement. Weâ€™ve wrote extensively about what to expect for the Fed meeting but at the end of the day, it all boils down to whether the central bank increases or signals plans to increase their balance sheet. Despite Bernankeâ€™s wishy-washy comments about recent non-farm payrolls, we know that nearly all other Fed voters including his sidekick Janet Yellen believe the U.S. economy needs more stimulus. By extending Operation Twist, which is all we expect from the Fed today, they are keeping monetary policy easy and the balance sheet unchanged. Anything more would help the dollar but given the recent rally in equities, the retracement in Spanish bond yields and the stabilization in currencies, the Fed will most likely remain in wait and see mode, which could rally the dollar if investors find it disappointing.
There are 3 potentially market moving FOMC events today and hereâ€™s what to expect from each of them.
#1 FOMC Rate Decision at 12:30pm ET / 16:30 GMT
Operation Twist to be extended by 6 months, watch for inclusion of mortgages
The FOMC statement should contain the announcement of an extension to Operation Twist. We expect OT to be extended by 6 months, which would buy the Fed more than enough time to assess the economy. If this is all it says, the dollar will probably rally a bit before Bernanke takes the stand but if the Fed also diverts some of those funds to mortgages, gains in the dollar could be capped.
Back in September 2011, when the Fed first launched the program, the Fed said â€œTo support a stronger economic recovery and to help ensure that inflation, over time, is at levels consistent with the dual mandate, the Committee decided today to extend the average maturity of its holdings of securities. The Committee intends to purchase, by the end of June 2012, $400 billion of Treasury securities with remaining maturities of 6 years to 30 years and to sell an equal amount of Treasury securities with remaining maturities of 3 years or less.â€ The statement this month will also continue to say that â€œthe Committee expects to maintain a highly accommodative stance for monetary policy. In particular, the Committee decided today to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that economic conditions–including low rates of resource utilization and a subdued outlook for inflation over the medium run–are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014.â€
#2 â€“ Fed Economy and Interest Rate Forecasts at 2:00pm ET / 18:00 GMT
Economic Projections to be Downgraded, 7 Fed Officials Saw First Rate Hike in 2014
Given the deterioration in non-farm payrolls and retail sales, economic projections will most likely be downgraded which would be bearish for the USD, particularly against the JPY. As for the Fedâ€™s interest rate projections, back in April, 9 members of the FOMC saw interest rates at 1% or less at the end of 2014 versus 0.75 percent in their previous survey. Seven Fed officials saw the first rate hike in 2014 versus only five back in January. The dollar will suffer if fewer than 7 FOMC members see a 2014 rate hike and in contrast, it will rally if there are more than 7.
#3 â€“ Bernanke Press Conference at 2:15pm ET / 18:15 GMT
Bernanke will Keep QE Expectations Alive
In our opinion, Bernanke will most likely keep QE expectations alive by saying they are prepared to increase stimulus if the economy weakens, which could be enough to validate the weakness of the U.S. dollar. However, he has surprised us on numerous occasions with comments that conflict with data. As a result, we do not rule out the possibility of him creating more confusion than clarity for the markets.
Meanwhile Spanish bond yields continued to decline on the hope that Europe is moving closer to a fiscal and banking union. This has helped eased the anxiety in the market and driven the EUR/USD higher.