What can we expect from the Fed?

Wednesday sees the latest Federal Open Market Committee decision, and markets are entering the traditional cautious phase usually seen in advance of this announcement.

Janet Yellen is about to begin chairing her first Federal Reserve meeting, marking the real beginning of the change in leadership that was first discussed a year ago.

Reduction of QE

As we look at the current environment, we know that the world’s most powerful central bank remains committed to a gradual reduction in the pace of its asset purchases. Since Autumn 2013, the Fed has been cutting $10 billion per month from its shopping trip, seeking to wean global markets off the ‘easy money’ (to use the pejorative term) that helped sustain investor confidence throughout the dark post-2008 phase.

At present, the Fed sees no reason to deviate from its current course. US data has got weaker of late, but poor weather in North America will have played a part in this. Interest rates will remain unchanged, as will the current pace of tapering (with QE3 expected to be fully wound down by the end of this year), but the area of interest will be any developments in forward guidance.

A return to normality

The Fed has been looking to move away from simply targeting a threshold in the US unemployment rate (around 6.5%), and is instead aiming to view the whole labour market, including job creation and the rate of participation (i.e. how many potential workers are not seeking new opportunities). This is perhaps the beginning of a shift back to more ‘traditional’ central banking, moving away from active economic support and instead helping to guide the economy along through the judicious use of language. It is, perhaps, not as thrilling, but it is a sign of a gradual return to normality.

Return of the rallies?

Any suggestion that the Fed is evolving a new view of the labour market, or that it expects a still-longer period of low interest rates, could result in a positive direction for stock markets. Gold traders would ideally want to hear a weaker assessment of the economic situation, since that would indicate a possible reduction in tapering, giving the precious metal a further boost in its current rally. The FOMC meeting at the end of January saw the S&P 500 end the day 0.9% lower, while spot gold was practically unchanged. Tomorrow’s meeting (and the associated press conference) could determine whether the current rallies in these markets continue.

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