FOMC preview: will Fed bring new dovish shift?

A government shutdown, coupled with the ongoing US-China trade spat, is finally taking its toll on the US economy, bringing a potential dovish shift from the FOMC at this week’s meeting.

Jerome Powell Source: Bloomberg

The Federal Open Market Committee (FOMC) seems to be in the process of shifting out of a period of quarterly rate hikes, towards a more standoffish phase of monetary tightening. US President Donald Trump has been a continuous feature when it comes to monetary policy commentary, with the president insisting that he could yet replace Chair of the Federal Reserve, Jerome Powell, if he persists with his anti-growth tightening policies.

No doubt the FOMC will have wanted to prove their independence by remaining on their chosen pathway, yet with the US-China trade spat having a clear impact upon growth and business confidence, there is reason to believe that the rate of ascent in US rates will begin to slow. Recent appearances from different members of the FOMC have proven relatively consistent with their tone, talking of patience and the willingness to wait. That alludes to a more data-reliant approach from the Federal Reserve (Fed), with the economic calendar having a greater influence on market sentiment.

Data-wise, we have seen a notable decline across a range of statistics, with the gross domestic product (GDP) growth rate slowing in the fourth quarter (Q4), and the purchasing managers index (PMI) surveys drifting lower over recent months. The government shutdown has cost the US economy $11 billion over the past month, and with Trump threatening to reignite the standoff in February, the impact could yet be larger. There are several headwinds to contend with, and with interest rates currently standing at 2.25%-2.50%, this is a good time for the central bank to hold off and survey the impact of their current policy standing.

Onto what is expected for this meeting. Markets widely anticipate that the committee will hold off on raising rates over the coming months, yet with issues such as China and the government shutdown likely to help dictate future economic developments, traders will be aware that the more hawkish stance could return if those issues are finally put to bed. Keep an eye out for the Fed’s interpretation of economic strength, with any revisions to their economic assessments potentially impacting their forward guidance to rely more on economic data. Also watch out for any updates on the Fed’s balance sheet reduction plan. That being said, Powell has already stated that the balance sheet reduction should occur in the background, with interest rates being utilised as the main influence on the US economy.

Looking out for the market reaction, we have seen the Dow Jones rallying impressively since Powell’s dovish statement on 4 January. With the price approaching the 76.4% resistance level at 25,002, watch for some form of response between the current trendline resistance and that Fibonacci level. A statement that points towards a likely resumption of rate hikes would be expected to cause the market to turn lower in line with the wider bearish trend. However, should we see a more dovish policy outlined, this week’s FOMC meeting could provide the spark needed to break through that area of resistance and towards the 26,072 peak. Should that occur, it would signal an end to the downtrend that has dominated sentiment over the past four months.

Dow Jones daily chart

Dow Jones daily chart

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