Pre-FOMC Scenarios and Market Reactions
There is a lot of speculation for tomorrow's rate decision by the FOMC. I'm here this evening to give you plain and simple low-down for what to expect with a choice of 3 scenarios and in turn the market reaction from each.
First of all, so we're all on the same page, In the United States, the federal funds rate is the interest rate at which depository institutions (banks and credit unions) lend reserve balances to other depository institutions overnight, on an uncollateralized basis.
Secondly, when I say the term "dovish", it means that policymakers favor looser, more accommodating policy because they want to stimulate growth in the economy.
Next, let's get on the same page when the technicals for the U.S. Dollar, where we can assert a few things, then I'll dive right into what to expect from the reaction of the market to a variety of possible scenarios for tomorrow.
Lastly, what're the FED's duties? Termed the "dual mandate", the FED's to focus on inflation and unemployment. Plain and simple.
The bigger focus other than the rate decision is the dot plot matrix contained within in the summary of economic projections, which in lamens terms translates to how dovish is the FED for the remainder of the year and where do they see rates going for the second half of 2019.
Pre-Rate Decision
There is a 22.5% of a rate cut by the FED tomorrow. (I think this is understated)
More interesting, however, is looking at the current statistics going forward to the last rate decision by the FED later this year in December.
(See Above)
There is a 2% chance of no hikes throughout the year.
There is an accumulative chance of 83.3% that the FED will cut at least once and as many as 3 by the end of 2019.
This is what has been driving the Dollar-- seen on last Friday's Dollar (DXY) rally-- which I covered this last weekend in depth. The moves we've seen today in equities also reflect this anticipation of a rate cut. The month of May was absolutely brutal for U.S. equities. This was triggered around the Federal Reserve's April rate decision which was announced on May 1st. Some of you may remember Powell's remarks at the press conference as being "muted" and/or non committed towards future rate cuts. In return, equity markets didn't respond positively at all. In short order, we had broken out of the rising wedge for the S&P500 which I covered in depth on my Instagram-- calling the downside target of 2800 which was hit within 3 weeks to the exact pip (instagram.com/p/Bw-MqQtAO4O/)
The change of pace that was seen in May/June was due to the FED's reassuring subtones that they would do whatever it takes to keep the "recovery" (from the lows at the end of June)on track. Also seen similarly in Q4 of last year.
Since then, as of today, we're just shy of all-time highs.
Scenarios and Marke Reactions Tomorrow
It's pretty well assumed that Powell and the FED will go dovish. Just so you're clear, this is a complete shift from the subtones given in the meeting on May 1st. This dovish shift will be seen in the summary of economic projections which will be live streamed on our free telegram channel tomorrow.
t.me/alchfx
I think the strength of the dollar seen today and the follow-through from last Friday's rally, signifies that traders are not expecting the FED to be as dovish as may be feared from Powell's comments when the dollar fell 100 basis points two weeks ago from tomorrow.
Scenario 1:
No rate cut (most likely in my opinion)
The FED projection of only 1 rate cut in tomorrow's dot plot matrix.
Reaction: An identical reaction to what happened in early May to the S&P500 (linked above on my Instagram post)
Scenario 2:
No rate cut, but a dot plot matrix with 3 projected rate cuts this year.
Reaction: Dollar strength, a quick jump followed by a pullback, where my upside target for DXY would be 98.
Scenario 3:
A surprise rate cut (22.5% chance)
The FED makes a case for 3 rate cuts for the remainder of this year. This would give the markets 50 basis points of softening over the remainder of this year.
Reaction: A bullish response across equities. An extreme response, being the catalyst to new all-time highs, and a potential 100 upside target for the Dollar index (DXY)
I think there is a better chance than this, but would say less than a 40% chance)
Here's why.
The FED talks about "game theory". For those that don't know, this is the act of making decisions with the anticipation of the reaction to certain situations. The FED's already planning ahead of their decision tomorrow. They've literally pinned themselves into a corner here though, and if they simply try to guide markets based on forwarding guidance by the dot plot matrix, expect an even tighter corner. In essence, they will be pre-committing to a rate cut well before any data is known (we're talking about 6 months in the future for a government entity that is retroactive in nature).
The Take Away:
Forward guidance is an encumbrance in a rising rate environment.
In a falling rate environment, this is music to market participants ears. Forward guidance really only became relevant in 2011, as a way to transmit from the central banks to the market that taking risk is okay.
Once you begin to talk about a falling rate environment, you start to mess with a whole different type of market player. I'm now talking bondholders. Long term debt holders who are essentially being approached with a machete to be scalped alive. This is not the part of the market, especially the holders of the safest sovereign debt in the entire world, that you want to try to scalp; to say the least.
The FED will attempt to handle this situation in a forward-looking manner with data that is 6 months away.
In the FED's defense
How can the fed deliver? The underlying data doesn't justify 3 rate cuts by the end of 2019. Inflation numbers last week came out very close to the FED's 2% goal. From an inflation standpoint, there's not a lot of motivation for the FED to get accommodative all of a sudden.
instagram.com/taylor.forex/
instagram.com/alchemy.fx/
instagram.com/layne.fx/
thefxblogger.com/
First of all, so we're all on the same page, In the United States, the federal funds rate is the interest rate at which depository institutions (banks and credit unions) lend reserve balances to other depository institutions overnight, on an uncollateralized basis.
Secondly, when I say the term "dovish", it means that policymakers favor looser, more accommodating policy because they want to stimulate growth in the economy.
Next, let's get on the same page when the technicals for the U.S. Dollar, where we can assert a few things, then I'll dive right into what to expect from the reaction of the market to a variety of possible scenarios for tomorrow.
Lastly, what're the FED's duties? Termed the "dual mandate", the FED's to focus on inflation and unemployment. Plain and simple.
The bigger focus other than the rate decision is the dot plot matrix contained within in the summary of economic projections, which in lamens terms translates to how dovish is the FED for the remainder of the year and where do they see rates going for the second half of 2019.
Pre-Rate Decision
There is a 22.5% of a rate cut by the FED tomorrow. (I think this is understated)
More interesting, however, is looking at the current statistics going forward to the last rate decision by the FED later this year in December.
(See Above)
There is a 2% chance of no hikes throughout the year.
There is an accumulative chance of 83.3% that the FED will cut at least once and as many as 3 by the end of 2019.
This is what has been driving the Dollar-- seen on last Friday's Dollar (DXY) rally-- which I covered this last weekend in depth. The moves we've seen today in equities also reflect this anticipation of a rate cut. The month of May was absolutely brutal for U.S. equities. This was triggered around the Federal Reserve's April rate decision which was announced on May 1st. Some of you may remember Powell's remarks at the press conference as being "muted" and/or non committed towards future rate cuts. In return, equity markets didn't respond positively at all. In short order, we had broken out of the rising wedge for the S&P500 which I covered in depth on my Instagram-- calling the downside target of 2800 which was hit within 3 weeks to the exact pip (instagram.com/p/Bw-MqQtAO4O/)
The change of pace that was seen in May/June was due to the FED's reassuring subtones that they would do whatever it takes to keep the "recovery" (from the lows at the end of June)on track. Also seen similarly in Q4 of last year.
Since then, as of today, we're just shy of all-time highs.
Scenarios and Marke Reactions Tomorrow
It's pretty well assumed that Powell and the FED will go dovish. Just so you're clear, this is a complete shift from the subtones given in the meeting on May 1st. This dovish shift will be seen in the summary of economic projections which will be live streamed on our free telegram channel tomorrow.
t.me/alchfx
I think the strength of the dollar seen today and the follow-through from last Friday's rally, signifies that traders are not expecting the FED to be as dovish as may be feared from Powell's comments when the dollar fell 100 basis points two weeks ago from tomorrow.
Scenario 1:
No rate cut (most likely in my opinion)
The FED projection of only 1 rate cut in tomorrow's dot plot matrix.
Reaction: An identical reaction to what happened in early May to the S&P500 (linked above on my Instagram post)
Scenario 2:
No rate cut, but a dot plot matrix with 3 projected rate cuts this year.
Reaction: Dollar strength, a quick jump followed by a pullback, where my upside target for DXY would be 98.
Scenario 3:
A surprise rate cut (22.5% chance)
The FED makes a case for 3 rate cuts for the remainder of this year. This would give the markets 50 basis points of softening over the remainder of this year.
Reaction: A bullish response across equities. An extreme response, being the catalyst to new all-time highs, and a potential 100 upside target for the Dollar index (DXY)
I think there is a better chance than this, but would say less than a 40% chance)
Here's why.
The FED talks about "game theory". For those that don't know, this is the act of making decisions with the anticipation of the reaction to certain situations. The FED's already planning ahead of their decision tomorrow. They've literally pinned themselves into a corner here though, and if they simply try to guide markets based on forwarding guidance by the dot plot matrix, expect an even tighter corner. In essence, they will be pre-committing to a rate cut well before any data is known (we're talking about 6 months in the future for a government entity that is retroactive in nature).
The Take Away:
Forward guidance is an encumbrance in a rising rate environment.
In a falling rate environment, this is music to market participants ears. Forward guidance really only became relevant in 2011, as a way to transmit from the central banks to the market that taking risk is okay.
Once you begin to talk about a falling rate environment, you start to mess with a whole different type of market player. I'm now talking bondholders. Long term debt holders who are essentially being approached with a machete to be scalped alive. This is not the part of the market, especially the holders of the safest sovereign debt in the entire world, that you want to try to scalp; to say the least.
The FED will attempt to handle this situation in a forward-looking manner with data that is 6 months away.
In the FED's defense
How can the fed deliver? The underlying data doesn't justify 3 rate cuts by the end of 2019. Inflation numbers last week came out very close to the FED's 2% goal. From an inflation standpoint, there's not a lot of motivation for the FED to get accommodative all of a sudden.
instagram.com/taylor.forex/
instagram.com/alchemy.fx/
instagram.com/layne.fx/
thefxblogger.com/
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