Wall Street Is Expecting One Thing Tomorrow, But The Fed May Have Something Else In Mind
Matthew Boesler
Janet Yellen
REUTERS/Jonathan Ernst
U.S. President Barack Obama (L) applauds after announcing his nomination of Janet Yellen (R) to head the Federal Reserve at the White House in Washington, October 9, 2013.
All we get from the FOMC tomorrow is a single statement.
There will be no press conference, and no updated forecasts.
Thus, market participants will be parsing every sentence of the statement, due out at 2 PM ET, to see how the views of the Federal Reserve's monetary policymaking body have changed since its mid-September decision that shocked Wall Street and caught markets off guard.
At that meeting, the FOMC elected to refrain from tapering the pace of monthly bond purchases it makes under its quantitative easing program, citing both inadequate improvement in economic data since its June meeting and the looming fiscal showdown in Washington, D.C.
"We have never heard investors as angry as the day after the Fed decided to not taper its asset buying program," said BofA Merrill Lynch economist Ethan Harris . "Some investors argue that it was a deliberate attempt to introduce volatility into the market. Others said Fed credibility is shot."
The government shutdown and debt ceiling debate that ensued caused economists at BofA Merrill Lynch and Société Générale to slash their GDP growth forecasts for Q3 and Q4 (BAML cut its Q1 2014 forecast as well).
In light of the damage the shutdown is said to have likely caused the U.S. economy, the decision not to taper in September seems justified in the minds of market participants, and expectations for the first tapering of QE have been pushed out to 2014.
"Most agree that the Fed did the right thing by skipping tapering," says George Goncalves, head of rates research at Nomura. He quotes a client who said, "Imagine if they tapered, where stocks and bonds would be now, given the weak backdrop and never-ending fiscal fights."
That brings us to this week's meeting, at the conclusion of which on Wednesday afternoon the only thing investors will get to look at is the FOMC statement.
"Just because the Fed is unlikely to taper at the October FOMC meeting does not mean the October FOMC meeting will pass quietly into the night," warn Morgan Stanley interest rate strategists Matthew Hornbach and Guneet Dhingra. "The market should focus on how the Fed changes the official statement because it could send important signals about future policy actions (or lack thereof)."
So, the main question is: will the statement come across as hawkish, or dovish?
"There is no risk of the 30 October FOMC surprising on the hawkish side," asserts Vincent Chaigneau, global head of rates and FX strategy at Société Générale.
"Our central expectation is ' no change' on all counts: rates, asset purchases, rate & QE guidance, and even on their current economic assessment," add SocGen fixed income strategists Jorge Garayo and Marc-Henri Thoumin. " Interestingly, our economists believe the language is going to be skewed to the dovish side, with the main risk being a tweak in the assessment of the economic conditions."
Goldman Sachs economists Sven Jari Stehn and Jan Hatzius, like their SocGen counterparts, believe the FOMC will modify the language addressing the economy in its statement, saying they " expect two small changes to the outlook paragraph."
"First, it appears likely that the committee would want to acknowledge the softer labor market data," write Stehn and Hatzius in a note to clients. " For example, the committee could state that labor market indicators have improved only 'on balance.' Second, the statement might reflect the uncertainty introduced by the government shutdown and debt ceiling fight ... For example, the committee could add that 'the recent fiscal debates have raised uncertainty around the near-term outlook' to its statement that fiscal policy is restraining growth."
The Goldman economists suggest an even more subtle tweak the FOMC could make in Wednesday's statement that does not concern the language surrounding the economy: "For example, the committee could change the phrase 'in judging when to moderate the pace of asset purchases…' into 'in determining the appropriate future pace of asset purchases….'," they write.
In short, much of Wall Street is expecting the FOMC to strike a deliberately dovish tone.
"Markets are now abuzz that a dovish FOMC statement could lead to interpretations of tapering being taken off the table completely until late Q1-14," says SocGen strategist Kenneth Broux. "If that does end up being the case, the greenback will face further selling pressure and 10y yields could test 2.40%."
But what if that doesn't end up being the case?
Steven Englander, global head of G10 FX strategy at Citi, thinks a hawkish tilt is actually the most likely scenario, if only slightly.
"The baseline view that the FOMC does as little as possible seems both correct and advisable," he writes in a note to clients. "Given how the market has shifted in its expectations, the room for the FOMC to surprise on the dovish side may be limited. Nor does it seem likely that they want to roller coaster the market yet again by putting tapering on the agenda on a faster track than the market is now pricing in. However, it seems to us slightly more likely that they try and keep tapering on the agenda without explicit timing, and that may be more hawkish than what is now expected."
BofA Merrill Lynch economist Michael Hanson, one of the few on the Street to correctly predict the Fed's September decision, is already looking past the statement to the minutes of the meeting, which will be released November 20.
"As the 'framework' for tapering that Chairman Bernanke laid out in the June press conference no longer appears valid, we expect an in-depth discussion of the economic factors that might warrant tapering, and how the Committee could improve communications around both asset purchases and the exit strategy," Hanson writes in a note. "But we don’t anticipate any resolution to these issues at the October meeting."
ISI vice chairman Krishna Guha, a former New York Fed official who served as a senior adviser to New York Fed president and FOMC voting member Bill Dudley as recently as early September, agrees that the minutes "will be much more interesting than the statement, since they will provide more color regarding the extent to which the committee is troubled by the substantial shift outwards in market QE expectations and the risk of being trapped in 'QE infinity' if the data does not cooperate in the coming months."
