Market Analysis

Fed Preview: Joining the Dots

Wednesday’s Federal Reserve Open Market Committee (FOMC) decision and statement marks the key central bank event of the week, and while markets have a zero expectation of the FOMC moving on US rates, the meeting remains important. The Fed should announce details of plans to reduce the size of its balance sheet. The recent deal in Washington that extended the US government’s debt limit until December has likely only made that eventuality more probable, as it removed one uncertainty that otherwise might have given the FOMC pause for thought.

As the initial mechanical process has already been set out traders might expect to see evidence that, in the words of the Netherlands’ Rabobank, “only principal payments that exceed gradually rising caps will be reinvested.” US bank BNYMellon summarizes the likely measures as “monthly Treasury caps of US$6 billion and [Mortgage Backed Securities] caps of US$4 billion” with those “amounts expected to increase by US$6 billion/US$4 billion [respectively] each quarter until they hit caps of US$30 billion/US$20 billion per month at the start of the second year of the programme.” Additionally there will be a focus on the Fed’s dot plot, which gives markets a snapshot sense of what the Fed may be thinking about the pace of rate moves in coming months. The “the most recent dot plot, published in June, implied three hikes in 2017,” Rabobank wrote. The question is whether this Wednesday’s dot plot will support that view or not.

Written by Neal Kimberley, External Currency Analyst.