​​FOMC preview: what now from the Fed?

The Federal Open Market Committee (FOMC) comes back into the fray for traders this week, with the latest two-day virtual meeting coming to a head on Wednesday 10 June.

With central banks and governments doing everything they can to aid an economic and market recovery, many will question exactly what the Federal Reserve (Fed) can do from here. There are a number of factors for traders to consider for this meeting.

US economic picture starts to improve

Friday’s US jobs report shocked everyone with a positive payrolls number and decline in unemployment confounding even the most optimistic market forecasts.

However, despite gradual improvements to jobs data and rising demand for goods such as cars and mortgages, there is certainly a lot more to do if we are to get back into anything like a healthy position.

Nevertheless, with lockdown measures gradually easing, there is plenty of reasoning behind the idea that we could see an economic upturn if the coronavirus stays away.

Unfortunately, that is unlikely to come in time for the second-quarter (Q2) gross domestic product (GDP) number, with growth expected to provide one of the worst quarterly growth figures in US history. As such, there are arguments on both sides here, with markets looking closely for changes to the FOMC economic projections.

The Fed is likely to take a somewhat cautious approach when forecasting future growth, with the possibility of a second wave of infections expected to keep economic activity relatively depressed.

Will the Fed go negative?

There is little appetite for negative rates at the Fed, as exemplified by market pricing. Refinitiv is currently pricing in a 92% chance that we will see the FOMC keep rates steady at 0%-0.25%.

On the flipside, they see a 7.9% chance that the committee could raise rates by 25 basis points. Nevertheless, keep an eye out for the latest dot plot as a gauge of where rates go from here.

What else could the Fed do?

With interest rates unlikely to move, many will look for a potential change to forward guidance from the Fed given Friday's jobs report.

However, with a cautious approach likely, it is very possible that we see little change on that front. Funding from the Fed will likely remain accommodative as we move forward, and they are likely to reiterate their willingness to act when necessary.

On the quantitative easing (QE) front, we have seen the amount of daily Treasury purchases dropping to around $4 billion per day, compared with the $75 billion seen around the onset of this crisis.

This decline is likely to continue, yet the FOMC will be expected to provide a supportive backdrop that highlights how they are willing to provide whatever liquidity is necessary given market environments.

Yield curve control

Many people have speculated that we could see the Fed implement a yield curve control policy (YCC), where the committee seeks to target specific yields in a bid to avoid a swift rise in borrowing costs.

Famously utilised by the Bank of Japan (BoJ), the use of YCC allowed them to control yields on ten-year bonds under control despite purchasing less bonds.

While the Fed may not implement this policy quite yet, it appears likely that they could use it as a means to avoid a spike in yields. The ability to keep Treasury interest rates low is important as it can feed through into keeping costs such as mortgage rates, car loans and corporate debt low.

That should in turn encourage further investment on both a personal and business level. From a market perspective, lower rates should help encourage elevated stock prices and lessen demand for the dollar.

Where now for the dollar?

The greenback has been on the back foot over the two weeks, with the dollar index exiting its April-May consolidation phase in style.

We are seeing some support come into play here, with the stochastic turning higher from oversold. A rise back through the 20 level for the stochastic could point towards a more bullish momentum coming into play. However, the downtrend still remains intact for now.

The four-hour chart highlights the slowdown we have seen of late, with the price trading largely sideways since Thursday's sharp decline.

Nevertheless, there is a good chance that this is a precursor to further downside, with a rally through 9761 required to negate this bearish trend.

Until then, watch out for whether we respect Fibonacci resistance, where the price continued to toy with the 50% threshold today (9701).

S&P 500 declines take us close to key support

On the stock front, the S&P 500 has seen early declines as it follows the European lead. However, the uptrend remains intact as long as the price fails to break below the 3182 support level.

With trendline support currently providing the basis for a gradual move higher, there is a possibility we will see the uptrend continue from here. Alternatively, a decline below 3182 would signal the potential for a wider pullback for this index.