FOMC Decision and GDP Loom Over US Dollar, Treasuries

How Will The Markets React?

As was expected US markets paid little attention to the sole market moving indicator released Tuesday. Even though consumer confidence hit a near four-year high this month, the direct impact tomorrow’s growth report and Federal Reserve rate decision may have on stocks, debt and currencies is too great to ignore. Expectations surrounding tomorrow’s data are clear cut, and this may prove costly for investors with open positions backing their personal forecasts. For Wednesday, the fundamental action will start well before capital markets open in the US. Economists expect the advanced read on fourth quarter GDP will come in at a round 3.0 percent. Even though the official consensus is already earmarking a considerable acceleration in growth, the masses may be slightly more optimistic on the number. If traders are already preparing for a better than expected number, it may discount the actual print. Furthermore, since official exchange trading hours begin a full hour after the GDP announcement, market participants in both the debt and equities markets have enough to time to fully digest the data – a definite impediment to momentous moves usually seen right after releases. Later in the day, however, everyone will have a shot at responding to the FOMC rate decision. Like the GDP report, the markets are expecting a lot from the event. Most know there is almost no chance for a shift in the overnight lending rate, but every word from the short statement that follows the decision could prove market moving. Traders will look for any hint that the Fed is turning hawkish on the economy, with specific interest surrounding a mention of a possible bottom in the housing slump. Alternatively, with all the tension leading into the day, an uneventful pass on both growth and the Fed’s part would generate considerable disappointment and open the door for Friday NFPs.

Bonds – US 10-Year Note Futures

Treasuries have budged little over the past three trading sessions. With the possibility of a shocking print for GPD and/or a shift in sentiment coming out of the FOMC statement due tomorrow, few investors will take the gamble of ignoring the inherent risk. As of Tuesday, the low in T-note futures was clearly stamped at 106-06 from last Friday’s low. However, this level has little technical significance, and a better than expected print in annualize GDP or the recognition of a possible turn in the housing market from the Fed could easily extend the move. Conversely, a hearty heaping of disappointment could paint treasuries ‘oversold’ and offer a considerably sharper move. Though, if a rally is triggered, a move higher would likely stop short of the channel top, leveraging a payrolls surprise.

FX – US Dollar Index

The dollar index continues to trade in a relatively tight range, with markets holding back speculative bets ahead of top-tier economic data. Given the significance of tomorrow’s GDP and FOMC news releases, traders are unwilling to commit to large dollar positions in fear of weaker data prompting sharp retraces in strength. What positioning remains, however, is tipped towards dollar bullishness. Friday’s Commitment of Traders report shows that USD positioning grew slightly more upbeat through the most recent sampling period, with traders holding a net 21,969 implied dollar longs. This could run into considerable danger if tomorrow’s releases disappoint, however, with the rising November-January trendline just 0.6 percent below today’s close. A soft GDP read could instantly prompt a dollar sell-off, as built up confidence would quickly whither away if growth figures do not match high expectations. If numbers fall in line, we could easily see an equally worrisome Greenback test following the afternoon’s FOMC Rate Decision. Dollar bulls hope that the trade-weighted DXY will hold above 84.50, confirming a continuation of strength through the short term.

Equities – S&P 500 Index

Much like the domestic currency, US equities remain at a significant crossroads ahead of tomorrow’s economic reports. Recent tests of a rising 3-month trendline underline waning bullishness on the world’s largest equity markets, with fears of high interest rates undercutting an otherwise solid outlook on corporate profitability through 2007. Stocks previously enjoyed significant bids as speculators wagered that the Federal Open Market Committee would move to cut interest rates through the coming quarters. With the probability quickly fading, however, many market commentators have begun calling an end to Wall Street’s 4-year bull market. Given interest rate sensitivity, traders will be paying exceedingly close attention to tomorrow’s FOMC rate decision and subsequent commentary—leaving risks to the downside if officials become more hawkish in their outlook for monetary policy.