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It’s a big challenge to be on the right side of the US dollar trade heading into the Fed meeting. As a result, reacting to the announcement is probably a better play, as the trade will probably have a long way to run after the fact. The FOMC statement is released at 4am (AEST) tomorrow morning and this will be followed by a speech from chairman Ben Bernanke at 4.30am (AEST), potentially increase volatility across the board.
Data in the US has been okay, but hardly enough to warrant a sizeable cut to its $85 billion a month bond-buying programme. The two key metrics which the Fed pays attention to, given its dual mandate, are price stability and full employment, and neither is brilliant. The 160,000 jobs created on average over the last six months is 40,000 below Chicago Fed president Charles Evans' target of 200,000. Core PCE at 1.2% is also significantly below the Fed’s longer-term target of 2.5%.
There are three things that are fundamental to tonight’s meeting. The first is how much (if at all) the Fed will lower its asset purchase programme. As things stand we feel the market is pricing in a $5 to $10 billion cut in the pace of the buying, although there are different thoughts as to whether this will be solely limited to US treasury buying, or both US treasury and mortgage-backed security buying.
Any more than $10 billion should be USD positive and negative for equity and bonds (yields up). Gold and equity bulls will be hoping the bank doesn’t cut at all, potentially signalling it could happen in December. We feel the risk is that tapering will be announced tonight, but actually start in October, so the Fed has more time to smooth over any volatility this may cause.
Point two is around the Fed’s economic projections and point three more about its forward guidance framework around what will be the triggers for a rise in the Fed funds rate. The Fed currently would look to hike the funds rate when the unemployment rate is seen hitting 6.5%, and this should still remain in place. There is a possibility we see the Fed provide clarification that the 6.5% unemployment threshold for putting up rates is conditional on inflation trending to 2%.
Japan’s Nikkei has had an incredible run today, jumping 1.8% and outperforming the region. Perhaps investors in Japan are betting on a tapering announcement to support the USD against the yen which would be positive for Japanese exporters. BoJ Governor Kuroda is also set to hit the wires tomorrow and some investors will be hoping for further clues on stimulus, particularly with the pending sales tax hike issue. Looking at equities in the rest of the region, the ASX 200 has shed 0.4%, while the Hang Seng and Shanghai Composite are also struggling to hang onto early gains.
Gold is one of the key assets to watch at the moment and has slipped below 1300 in Asia today as the threat of tapering looms. Gold traded as low as 1292, its lowest level since August 8. A close below the 50% retracement of the (1180 to 1434) move higher at 1307 would be bearish for gold. Should this happen the next support level will be the 61.8% retracement level at 1280.
European markets are currently pointing to a firmer open after having lost ground in yesterday’s session. Risk currency pairs have been fairly sidelined, with EUR/USD treading water around 1.335 and GBP/USD at 1.59. At 6.30 (AEST) we get Bank of England minutes and the market will be keen to explore for signs of how robust the Bank sees the recovery. Cable is overbought at present, although we feel pullbacks should be supported.
After a mildly firmer open, the local market has lost some ground with no confidence to hold on to positions at elevated levels. Materials are leading the slump, with the drop in iron ore and gold weighing on some of the key resource names. BHP, RIO, Fortescue and Newcrest have all slumped. Meanwhile the big banks have had a fairly solid session, with NAB leading the way after being upgraded to buy (from underperform) by BoAML. Regardless of what price action we see heading into the close today, tomorrow will be all about reacting to the Fed decision.