Fed Preview: Fearing market froth or boosting Biden's stimulus? Three scenarios


Share:
  • The Federal Reserve is set to leave its bond-buying plan unchanged and signal a steady hand.
  • Stocks may suffer if Fed Chair Powell warns about market froth.
  • By calling for fiscal stimulus, the bank may hint it is ready to scoop up debt, boosting shares.

Winter has come – it is darker than thought – but spring is also on its way. Will the Federal Reserve focus on the gloomy economic deterioration or remain upbeat about the near future and even warn about excesses? The answer is set to rock all markets.

Here are three scenarios for the Fed's first decision of 2021.

1) Play the waiting game

The bank is set to leave the interest rate unchanged near zero and also maintain its bond-buying plan at around $120 billion/month, as Federal Reserve Jerome Powell signaled in recent appearances. He may also refuse to provide any hints about changes to the policy, sticking to a conditional script. 

In this scenario – which has the highest probability – stocks may edge lower after their recent gains and the dollar is unlikely to make any substantial waves. Nevertheless, Powell may provide hints towards Thursday's growth figures

If the Fed Chair says that recent data was somewhat disappointing, investors may conclude that Gross Domestic Product data for the fourth quarter missed estimates. Retail Sales, Unemployment Claims, and Nonfarm Payrolls all missed estimates. The latter figure showed the first squeeze in the labor market since the spring, and the Fed may be worried that it could fall short of its employment mandate.

Source: FXStreet

If Powell says that the current weakness – a result of the virus's resurgence in the autumn and winter – was as expected, traders can expect GDP to meet or even beat estimates. 

2) Fearing the froth

The financial press has recently highlighted retail traders' feverish stocking of several shares such as Gamestop, Churchill and others. There are also fears about exuberant valuations of more established companies such as Tesla or even frothy valuations of tech giants. The pandemic has brought equity trading to the forefront. 

While the Fed statement is unlikely to address the stock market, reporters are likely to ask Powell about his thoughts and if he shows some concerns, markets could suffer. It would serve as a hint that the Fed will not always be there to support "favorable financial conditions". By pinching holes in markets, the Fed may be preventing a potential bubble. 

As the generosity of central banks is the critical driver of shares, any hint that the Fed is unwilling to continue printing money in fear of bubbles would send them down. The safe-haven dollar would greatly benefit in such a scenario. The greenback has been unable to stage a meaningful recovery and a hint from the Fed could set the spark for a rush to the "king of cash."

The Fed added some $3 trillion to its balance sheet in 2020:

Source: Federal Reserve

Such a scenario would also be backed up by the hope that COVID-19 vaccines would enable a robust recovery in the second half of 2021 – something the Fed has been consistent in predicting. 

3) The Powell Put is backing Biden's boost

President Joe Biden is pushing for a $1.9 trillion stimulus package. While he publically said that he is ready to negotiate, he is also aware of the high price and conveyed a sense of urgency – hinting that Democrats could go it alone. 

Even if the final coronavirus relief package is worth only $1.5 trillion, the government will need to find funding for this extra debt. Is there enough money in markets to scoop up Treasuries? The Federal Reserve may be able to end any doubts by indirectly committing to scooping up a significant chunk of freshly auctioned bonds.

Powell is unlikely to say that directly, but he could hint that a substantial increase in bond yields – a result of high debt issuance – will not be tolerated. So far, the bank has seen the increase of ten-year yields above 1% as a bullish sign for the economy. However, at some point, long-term interest rates would make financial conditions unfavorable

By keeping the door open for increasing the Fed's bond-buying scheme, equities would react positively to the Fed – and so would gold. The safe-haven dollar would suffer another sell-off amid prospects that the newly minted greenback would flow outside the US in search of riskier assets. 

Conclusion

While the world's most powerful central bank is set to leave its policy unchanged, it can undoubtedly rock markets by signaling its next changes in its bond-buying scheme.

See Five factors moving the US dollar in 2021 and not necessarily to the downside 

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 stays in daily range above 1.0800 after US PMI data

EUR/USD stays in daily range above 1.0800 after US PMI data

EUR/USD continues to fluctuate in its daily range above 1.0800 in the American session on Friday. The data from the US showed that ISM Manufacturing PMI declined more than expected in February, making it difficult for the US Dollar to gather strength.

EUR/USD News

GBP/USD holds above 1.2600 as USD struggles to gather strength

GBP/USD holds above 1.2600 as USD struggles to gather strength

GBP/USD staged a modest rebound after testing 1.2600 on Friday. Following the weaker-than-expected ISM Manufacturing PMI data from the US, the US Dollar struggles to preserve its strength and allows the pair pull away from session lows.

GBP/USD News

Gold jumps to fresh two-month high above $2,070

Gold jumps to fresh two-month high above $2,070

Gold gathered bullish momentum in the second half of the day on Friday and reached its highest level since early January above $2,070. The benchmark 10-year US Treasury bond yield is down 1% at 4.2%, fueling XAU/USD's rally ahead of the weekend.

Gold News

XRP surges to $0.62 ahead of key trial in class action lawsuit against Ripple

XRP surges to $0.62 ahead of key trial in class action lawsuit against Ripple

XRP price inched closer to its 2024 high, rallying past the $0.62 level on Thursday. The altcoin was hit by a correction, however, which pulled it back down to the $0.59s early Friday. 

Read more

Week ahead: ECB decision and US Payrolls to steal the show

Week ahead: ECB decision and US Payrolls to steal the show

Nonfarm payrolls and Powell’s testimony will be crucial for US dollar. European Central Bank could set the stage for summer rate cuts. Bank of Canada decision and UK budget announcement also in focus.

Read more

Majors

Cryptocurrencies

Signatures