With the FOMC policy decision looming, investors everywhere are on edge. How will the capital markets respond to what the Federal Reserve has to say?

FOMC Policy Decision and Economic and Interest Rate Projections (Wednesday, March 21, 2:00 p.m. ET)

Fed Chairman Powell's Press Conference (Wednesday, March 21, at 2:30 p.m. ET)

The Federal Reserve is the world's most influential central bank and markets around the world move on the heels of the FOMC policy meeting decision. This will be Fed Chairman Powell's first time at the helm. He will follow the policy decision with a press conference at 2:30pm EST. Investors will be paying close attention as it will give them a "feel" for how he will lead these meeting moving forward.

The expectation is that the FOMC will in fact raise the target range for the fed funds rate by 25 basis points (0.25%). The uncertainty however relies on the rhetoric that will come with/follow the expected move. Specifically, investors want to know how the Fed will adjust or present their projected rate path? 

s of December, the median estimate pointed to an expectation of three hikes in 2018. The market is on edge while entertaining the idea that the Fed is mulling a fourth rate hike in 2018. A fourth rate hike would be considered "hawkish" and (barring a change in narrative) be viewed as an overall negative paradigm shift. 

Currently, the futures market is signaling a 37.7% probability of a fourth rate hike in December. Some items to consider in the rhetoric include whether or not the Fed mentions anything regarding the potential stimulative effect from tax reform. Additionally, any mention trade measures will also be something to make note of.

The Fed will have to thread the needle amongst political and trade uncertainty. Any false move could exasperate reactions from market participants as they navigate the troubled environment. Additionally, some fear that the actions by the Fed would potentially drive the political landscape. 

Effective Fed Funds Rate (Courtesy of Briefing)

 

The target range for the fed funds rate was raised to 1.25% to 1.50% at the December 2017 meeting and left unchanged at the January meeting

At the September 2017 FOMC meeting, the Federal Reserve announced the start of its balance sheet normalization program, saying it will cap the reinvestment of principal from maturing Treasury securities at $6 billion per month initially, starting in October 2017, and increase it in steps of $6 billion at three-month intervals over 12 months until it reaches $30 billion per month.  Additionally, it will cap the reinvestment of principal from maturing agency and mortgage-backed securities during the normalization process at $4 billion per month initially, starting in October 2017, and increase it in steps of $4 billion at three-month intervals until it reaches $20 billion per month.

WHAT TO WATCH FOR:

DXY:

 It has been coiling into the 90 area. A failure to hold 90 would set up a key test of that 88.50 area.

Euro: 

The ECB is not showing any signs of increasing its hawkishness as the FX values are clearly in focus.

Equities:

A tighter consolidating pattern into this meeting. Bias is any signs of a fourth rate hike will be bearish for the group but that does not mean I am looking to jump all in short as the immediate reaction will be a little tougher to forecast.

Bonds: 

Seeing the 10-year pegged up against this 2.90% area ahead of the meeting. The general thought is that this should rip towards that key 3.00% level if the Fed turns the tightening screws more than expected.

Statement

Economy:

Jan 31: Information received since the Federal Open Market Committee met in December indicates that the labor market has continued to strengthen and that economic activity has been rising at a solid rate.


Inflation:

Jan 31: On a 12-month basis, both overall inflation and inflation for items other than food and energy have continued to run below 2 percent. Market-based measures of inflation compensation have increased in recent months but remain low; survey-based measures of longer-term inflation expectations are little changed, on balance; Inflation on a 12-month basis is expected to move up this year and to stabilize around the Committee's 2 percent objective over the medium term.


Accomodative:

Jan 31: The stance of monetary policy remains accommodative, thereby supporting strong labor market conditions and a sustained return to 2 percent inflation.. EVENT Comment: I would be interested to see what level the Fed would need to hit in order for it view its policy to be more neutral than accomodative.


Gradual Rising:

Jan 31: The Committee expects that economic conditions will evolve in a manner that will warrant further gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data

Dot Plot


A key item to watch as investors will be watching closely for any move toward a fourth rate hike.
At the moment the average dot plot has us at 2.02% in 2018. We are currently sitting at the 1.25-1.50% band so that suggests another three rate hikes to get us to 2.00-2.25%. A move closer to the 2.25% area would get investors thinking along the lines of four rate hikes.

2018 Central Tendency

Real GDP 2.2-2.6%; This was an increase from the 2.0-2.3% in September. Notable that it lowered the high end of its Longer run expectations to 1.8-1.9% (from 1.8-2.0%). This reflected some of the longer term concerns from new fiscal policies.
Unemployment Rate 3.7-4.0%; Lowered from the Sept projections of 4.0-4.2% as the full employment debate is under way.
PCE Inflation 1.7-1.9%; Lowered from Sept projection of 1.8-2.0% which was a slightly dovish nod.
Core PCE 1.7-1.9%; Lowered from 1.8-2.0% outlook in Sept.
Fed Funds Rate 1.9-2.4%; No change from Sept outlook. Lower end of the longer term guidance was raised to 2.8-3.0% from 2.5-3.0% in Sept.

The following areas are apt to see increased trading activity based on the market's interpretation of the FOMC's position:

  • Treasuries and related bond ETFs
    • ProShares UltraShort 20+ year Treasury (TBT)
    • iShares 20+ Year Treasury Bond (TLT)
    • iShares 1-3 Year Treasury Bond (SHY)
    • Schwab Short-term US Treasury ETF (SCHO)
    • iShares iBoxx $ High Yield Corporate Bond (HYG)
    • SPDR Barclays High Yield Bond ETF (JNK)
    • iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD)
    • iShares Floating rate Bond ETF (FLOT)
       
  • U.S. Dollar and related ETFs
    • DB USD Index Bullish (UUP)
    • DB USD Index Bearish (UDN)
       
  • Rate-sensitive sectors like utilities, REITs, and financials and related ETFs
    • Utilities Select Sector SPDR ETF (XLU)
    • iShares U.S. Real Estate ETF (IYR)
    • REIT ETF (VNQ)
    • Financial Select Sector SPDR ETF (XLF)
    • SPDR S&P Bank ETF (KBE)
    • SPDR S&P Regional Banking ETF (KRE)
    • SPDR S&P Insurance ETF (KIE)
       
  • Volatility ETFs
    • iPath S&P 500 VIX ST Futures ETN (VXX)
    • ProShares Ultra VIX Short-Term Futures (UVXY)
    • Pro Shares Short VIX Short-Term Futures (SVXY)
       
  • ETFs and inverse ETFs for the major averages
    • SPDR S&P 500 ETF (SPY)
    • Short S&P 500 (SH)
    • PowerShares QQQ Trust Series (QQQ)
    • Short QQQ (PSQ)
    • iShares Russell 2000 (IWM)
    • Short Russell 2000 (RWM)
    • SPDR Dow Jones Industrial Average ETF (DIA)
    • Short Dow 30 (DOG)