Share:
  • The Federal Reserve is in a difficult position, facing elevated inflation, a tight labor market and a nascent banking crisis.
  • Expectations went in a few days from a 50 bps hike to rising odds for no change.
  • What matters for the US Dollar: systemic risks or yields?

 
Less than two weeks ago, the Silicon Valley Bank (SVB) failed, marking the beginning of a banking crisis that is unfolding. Since then, a voice has been absent, the Federal Reserve. When the crisis emerged, FOMC officials were in the blackout period. The only public communication from the Fed had been several statements about the SVB situation and announcing global coordinated action to provide liquidity via swap line arrangements.

On Wednesday, markets will hear from the Fed for the first time. The US central bank must also announce its monetary policy decision and release new macroeconomic forecasts. Following Fed Chair Jerome Powell's testimony before the Senate two weeks ago, markets started to consider the possibility of a larger rate hike in March, reinforcing the view of “higher for longer” interest rates. A few days later, thanks to the banking turmoil, a 50 bps hike is off the table, and the odds for a no change are not irrelevant. Rate cuts before year end are priced in.

There has been a shock and market participants are still figuring out how it could hit the economy, employment and inflation. The Fed is also doing the same. But there is considerable uncertainty for all. If the Fed reacts on Wednesday, showing that it is very concerned and keeps rates unchanged because of the current crisis, it would probably not trigger a celebration but most likely spread fear to markets, triggering sharp declines in the stock, sending the US Dollar initially down, but then sharply higher, amid systemic risk fears. It happened during the 2008 financial crisis.

The problem for the FOMC is that they have to decide and project amid too many uncertainties surrounding the outlook. The market knows that what the central bank says on Wednesday is soon absorbed unless it is something that shocks.

What to look for:

  • Decision on monetary policy. The Fed is expected to raise its policy rate by 25 basis points to the range 4.75%-5.00%. However, some banks call for no change and a few for a rate cut.
     
  • Summary of Economic Projections (SEP), the “dot plot”. It would show how FOMC members see the current crisis affecting the economy and how the central bank would react in such a scenario. As the situation unfolds, the projections could change dramatically at the next release, but that won’t matter on Wednesday. Analysts will focus on potential rate cuts scenarios before the end of the year.
     
  • Powell press conference. Powell could add to the data-dependent mantra, a crisis dependent, not committing to a specific action in the future. It would be a surprise with inflation still elevated (the Consumer Price Index declined from 6.4% to 6% YoY in February and the core rate from 5.6% to 5.5%) if the Fed prioritizes stabilizing financial markets, putting aside the battle against inflation. Both objectives will likely be priority number one.

    During the press conference, markets could respond significantly if Powell speaks about possible rate adjustments in either direction. Particularly if he suggests that they would react if financial conditions tighten further.

    How Powell answers questions about the importance of lending conditions on Fed’s decisions is critical. Lending standards have already tightened and will likely keep going up. The problem is that financial conditions are subjective and quick to move. For example, just weeks ago, indicators of financial conditions were near their loosest in a year, and then went straight forward to the most restrictive in years.

 The decision, the dot plot and Powell’s words will show markets how the FOMC assesses the impact of recent volatility. That is crucial to the future interest rate outlook. 

 Unintended consequences
 

 – Extreme volatility. A rate cut or no change could create immediate shocks; also, a 50 bps hike.  With the financial world and traders looking at the Fed meeting, any outcome could trigger extreme volatility. Large price swings seem likely at the time of the announcement and during the first half of Powell’s press conference. The Fed would not want to trigger unintended consequences, but there always are. Markets could make a large story out of one word from Powell. Such influence could last a few minutes or days, favoring sharp price swings.

 – Limited reaction. It should not be ruled out. Last week, markets remained steady after the European Central Bank (ECB) meeting. The ECB acted as expected; macroeconomic projections were made before banking jitters, and Lagarde spoke carefully. The difference is that markets will hear from officials for the first time since the crisis, and the projections have to consider recent developments, and Powell is not Lagarde.
If the Fed acts as expected by raising rates and offers a cautious message, saying not much but the necessary, considering the uncertain outlook with high inflation, the reaction could be limited. The lack of clear forward guidance in the wake of the banking crisis, could contribute to markets not knowing where to go.

 – Risk on/Risk off.  If the Fed makes the dovish rate hike, it could help bring in some risk on, at least for a while. A no-rate hike, or a more dovish than expected tone, is likely to be cheered by markets but equally, that might not be the case. If markets see a frightened Fed, the fear could spread, leading to a rally in bonds, declines in Wall Street, a mixed US Dollar and probably a rally in Gold.

A decline in US yields weighs on the US Dollar. Even during the recent episode of risk aversion, the Greenback fell, as US yields sank. However, going into the future, with markets already pricing in a dovish Fed for the second half of 2023, a new rally in Treasuries could not be harmful to the Dollar if the key drivers are global systemic risks.

In the event of an unlikely “hawkish” Fed (a 50 bps hike), the initial reaction would likely be a US Dollar rally. The move's sustainably would depend on the message and the policy outlook. A “large last hike,” is not the same as a large hike keeping the doors open to more. A “hawkish” Fed could have a small positive impact on markets if it reflects confidence from the central bank that the ongoing banking crisis will not impact the economic outlook.

Surrounding events and economic data could soon overshadow the FOMC’s message, making the impact of the Fed meeting short-lived. A precise, clear, long-lasting forward guidance could be the Fed’s desire, but unachievable under current circumstances.

 

Share: Feed news

Information on these pages contains forward-looking statements that involve risks and uncertainties. Markets and instruments profiled on this page are for informational purposes only and should not in any way come across as a recommendation to buy or sell in these assets. You should do your own thorough research before making any investment decisions. FXStreet does not in any way guarantee that this information is free from mistakes, errors, or material misstatements. It also does not guarantee that this information is of a timely nature. Investing in Open Markets involves a great deal of risk, including the loss of all or a portion of your investment, as well as emotional distress. All risks, losses and costs associated with investing, including total loss of principal, are your responsibility. The views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of FXStreet nor its advertisers. The author will not be held responsible for information that is found at the end of links posted on this page.

If not otherwise explicitly mentioned in the body of the article, at the time of writing, the author has no position in any stock mentioned in this article and no business relationship with any company mentioned. The author has not received compensation for writing this article, other than from FXStreet.

FXStreet and the author do not provide personalized recommendations. The author makes no representations as to the accuracy, completeness, or suitability of this information. FXStreet and the author will not be liable for any errors, omissions or any losses, injuries or damages arising from this information and its display or use. Errors and omissions excepted.

The author and FXStreet are not registered investment advisors and nothing in this article is intended to be investment advice.

Follow us on Telegram

Stay updated of all the news

Join Telegram

Recommended Content


Follow us on Telegram

Stay updated of all the news

Join Telegram

Recommended Content

Editors’ Picks

EUR/USD hits fresh daily lows under 1.0500

EUR/USD hits fresh daily lows under 1.0500

EUR/USD continued to face downward pressure and matched last week's low at 1.0487. It is hovering around 1.0500, as the US Dollar remains strong, supported by higher Treasury yields. The 10-year Treasury yield reached 4.70%, a level not seen since 2007.

EUR/USD News

GBP/USD drops to six-month lows, eyes 1.2100

GBP/USD drops to six-month lows, eyes 1.2100

GBP/USD retreated further and dropped to 1.2107, hitting the lowest since mid-April. The pair remains under pressure amid higher US Treasury yields, following better-than-expected ISM September Manufacturing PMI data.

GBP/USD News

Gold approaches $1,800 as demand for the USD prevails Premium

Gold approaches $1,800 as demand for the USD prevails

Spot Gold fell to a fresh multi-month low of $1,827.11 a troy ounce on Monday amid resurgent  US Dollar demand. The Greenback suffered a minor setback at the beginning of the week, as generally encouraging Chinese data and upbeat United States (US) news underpinned the mood.

Gold News

Three altcoins that have kickstarted Q4 rally: LINK, RDNT, FLOKI

Three altcoins that have kickstarted Q4 rally: LINK, RDNT, FLOKI

Crypto market volatility seems to be making a comeback with the start of 2023’s fourth quarter , and some altcoins are already making headway. Chainlink (LINK), Radiant Capital (RDNT) and Floki Inu (FLOKI) are some cryptos that are showing aggressive upside moves. 

Read more

NIO contracts 2% as Tesla delivery decline weighs on EV sector

NIO contracts 2% as Tesla delivery decline weighs on EV sector

Nio (NIO) stock dropped 2.3% on Monday morning despite meeting its quarterly delivery target for the third quarter. Tesla's (TSLA) Q3 production and delivery decline is the culprit.

Read more

Majors

Cryptocurrencies

Signatures