Markets calm ahead of Federal Reserve meeting

By Jeff Davies

Investors in equity and foreign exchange markets are reluctant to take a direction before this week’s much expected Federal Reserve (Fed) decision. The S&P500 (+0.09%) and the Dow (+0.09%) closed flat on Monday. NASDAQ gained 0.62%, as technology stocks rallied.

The Fed will give its policy verdict on Wednesday and is expected to maintain its policy unchanged. However, markets are obsessed with the Fed’s next move, since the Fed Governor Jerome Powell said that they are ready to cut the interest rates, if needed. The Fed expectations sharply moved from ‘patient’ to two-to-three rate cuts within the next twelve months.

Now it is time to see whether Powell meant such a drastic policy shift. Despite the ongoing trade disputes and the weakness in the latest jobs report, the US economy grew just fine. The first quarter GDP printed 3.1% growth, while the unemployment rate is at two-decade lows. But some indicators hint that the good vibes in the US economy may not last. The Empire Manufacturing index printed the biggest one-month drop in history. The index dropped from 17.8 to -8.6 in June, leaving the already-soft expectation of 11.0 well behind. The inflation expectations in the US hit the lowest levels since 2016.

One thing is clear, the market is positioned for a dovish Fed. The question is, will the Fed sound as dovish as expected by the market?

In fact, the recent shift in Fed expectations created a domino effect. The Bank of Japan (BoJ) and the European Central Bank (ECB) announced that they could also lower their rates, despite being already in the negative territories. Meanwhile, the Reserve Bank of Australia’s (RBA) latest meeting minutes stated that further policy easing is more likely than not in the period ahead, after lowering its policy rate by 25 basis points this month.

As a result, the actual market expectations and other central banks’ dovish positioning could eventually force the Fed to act sooner, or sharper than it otherwise would. This is because the policymakers consider the market expectations and ride in tandem with investors to allow a smooth transition of policies into the market.

Hence, this week’s FOMC meeting is the moment of truth for Fed watchers. Have the markets gone beyond the Fed’s thinking? If so, will the Fed readjust its stance according to what markets demand. The Fed’s dot plot will perhaps give a clearer scope for what could happen in the coming months. A less dovish readjustment in the language could be a disappointment for the markets and send the US stock and bond markets tumbling. Therefore, the Fed could choose to follow the market’s lead and deliver a sufficiently dovish verdict until the dust settles.

The US 10-year yield consolidates below the 2.10% mark, as the US dollar softens against the G10 currencies this morning, except the Aussie and the pound.

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