Fed meeting looms

The big event of the week is the FOMC (Federal Open Markets Committee) meeting, at which the Federal Reserve may choose to meddle with its current monetary policy stance.

Federal Reserve building in Washington
Bloomberg: Source

The Fed is expected to cut $10 billion from its easing programme this week, in line with previous meetings. This is based on the view that the US economy is slowly improving, and a steady reduction is the best way to manage market expectations.

It should be borne in mind that the Q1 GDP reading for the US was dire, but the Fed are likely to suggest that this was a temporary blip, and that growth and inflation have both ceased to decline and are now headed higher. Expectations about economic growth have shifted lower, which opens the way for more positive surprises.

Generally, however, the Fed will keep to its current assessment, regarding the situation with cautious optimism. Quantitative easing might be cut by a larger amount this time, perhaps by $15 billion, and this may cause further losses in equity markets. However, the current rate of tapering still sees an end to QE purchases later this year, by which point the Fed believes the recovery will be more secure.

Any changes in the statement are likely to be relatively subtle, as the Fed slowly shifts to a more hawkish stance. Comments about rate hikes coming earlier than expected, such as those made by Mark Carney last week at the Mansion House, are almost certainly out of the question. They may also take note of geopolitical risk, given that the situation in Iraq appears to be getting out of control. Higher oil prices, and the follow on of higher fuel costs for Americans, would act as a brake on the economy; expect language from the Fed that will accommodate this.

Even when rates start to rise, the increases will be slow and steady. The Fed does not want to be caught behind the curve of rising inflation, but nor does it aim to choke off the recovery too early (a point that applies to the Bank of England too). The FOMC will aim to stick to the idea that low wage growth signals plenty of spare capacity in the economy (i.e. room for improvement) and low inflation, although as the situation improves the general consensus will begin to shift.

All Fed meetings are important, and will shift most markets. Volatility will increase around the announcement, and so the usual rules of loosening stops to avoid being stopped out by sudden movements applies. 

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