FOMC preview: Tapering talk key, as inflation remains elevated

The Federal Reserve keep markets guessing around taper talk, with the rise in Delta cases expected to result in a more cautious approach.

The Federal open market committee (FOMC) return to the fold this week, with investors keenly looking out for clues from a meeting that is likely to be more talk than action. That two-day meeting concludes on Wednesday 27 July.

Inflation fears remain

Recent months have seen a significant degree of uncertainty after the Federal Reserve (Fed) took a notable shift in tone away from their explicitly dovish and supportive stance seen since the beginning of the Covid-19 pandemic.

Instead, the recent rise in inflation has brought a more cautious approach, with the committee clearly losing confidence that this recent rise in prices will be transitory.

The chart below highlights how those inflationary pressures remain highly present, with both headline and core consumer price index (CPI) pushing through the 5% threshold. Notably, that takes core inflation to the highest level in 20-years.

Last month’s dot plot highlights how that rise in inflation has pushed outlook at the Fed, with a majority of members seeing rates rising in 2023.

​Meanwhile, we have also seen a total of seven members that foresee higher rates as early as next year.

Expectations of a 2022 rate rise are evident when looking at the market pricing of the first hike. Any rate rise at Wednesday’s meeting looks highly unlikely given the 0% currently priced in. However, the longer-term outlook sees expectations rise towards the end of 2022.

Delta variant could result in cautious approach

Despite the ongoing pressure brought about by soaring inflation, the rise of the Delta variant does provide the basis for a more cautious Fed this time around.

Despite 48% of the US enjoying full vaccination status, those efforts have been undermined by rise of the more contagious Delta strain which now accounts for 91% of US cases. The surge in Delta dominance has been simultaneous with a rise in cases, with new cases rising to the highest level since April 2021.

Tapering the key topic for traders

With a rate rise unlikely this year, traders will instead focus on tapering given the fact that the Fed will look to address their asset purchases scheme first. The ongoing quantitative easing policy helps to drive equity prices upward and a weaker dollar. With that in mind, any move to withdraw this stimulus would likely drive markets lower.

From an FX perspective, the dollar trajectory is less clear as the strength that could come from tighter policy can be counteracted by haven demand as equity prices head lower. ​While we are unlikely to see tapering commence yet, we are likely to see volatility if the Fed provides forward guidance on when tapering will start.

Dollar index technical analysis

The dollar has started to head lower as we move into this week’s meeting, with price falling back below the ascending trendline that supported price over the past month. The recent rally is yet to take us up through the prior high of $93.47, with the long-term downtrend yet to be debunked.

Until then, there is a risk of a move lower, with a decline through the $92.07 swing low bringing a more bearish outlook. Until that level breaks, there is a risk we could see the uptrend of the past two-months come back into play.

S&P 500 technical analysis

The S&P 500 is also weakening as we head into the meeting, with prices easing back from Monday’s record high. Should the Fed decide to bring a more hawkish stance, we could see this pullback extend. However, such a move would likely represent a retracement of the rally from 4232.

As such, even if we do see a somewhat unlikely roadmap for tapering laid out, it would likely present another opportunity to buy the dip. ​Meanwhile, a more patient approach would raise the likeliness of a swift move back towards previous highs

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Federal Reserve meeting

Find out how the Fed affects the markets ahead of the FOMC meeting taking place between 18 - 19 June 2019.

  • How might the next Fed meeting affect traders?
  • What was decided at the last Fed meeting?
  • How does the FOMC announcement usually affect the dollar?

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