Talking Points:
- Conviction across the markets has wavered and technical pressure has built, making the FOMC rate decision a risky event
- This is not one of the 'quarterly' rate decisions with forecasts and markets only see a 5 percent chance of a hike
- Focus will be in the policy statement where nuance will be measured for timing of future hikes and balance sheet plans
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Heading into the Federal Open Market Committee's (FOMC) third policy meeting for 2017, there is near certainty in the market that the group is going to hold policy steady. And yet, there is still a high probability that the Dollar can force a break from its narrow trading band, while broader risk-linked markets face breakouts of their own. This meeting will be considered one of the 'regular' policy decisions - as opposed to the 'quarterly gatherings which include the Summary of Economic Projections with direct rate forecasts and of course the Chairwoman's press conference. Looking back at the three hikes so far back to December 2015, all of the active moves occurred during one of the expanded events. That makes sense as the still unique decision to tighten policy where the rest of the world is increasing its rate of accommodation requires as much insight as possible in order to quell a pained speculative response. Officially, the Fed Fund futures place the probability of a hike at this particular meeting at a paltry 5 percent.
Of course, the certainty in a hold at this meeting doesn't automatically render this meeting a non-event. Quite the contrary, the lack of an overt outcome from this event means the market will look more closely at the nuance in forecasting future moves that have seen official and speculative projections diverge and converge over the past year. Looking further ahead at the June meeting, the chances of (at least one) hike is nearly 70 percent. Contrast that confidence to the general discount the market maintains on the Fed's own forecast for two rate hikes (50 basis points) as speculative interests given that measured hawkish outlook a 50-50 chance of being realized. There is plenty of room for the tides to change in this wide disparity. To assess the market's response, the language in the accompanying policy statement will be particularly important. Language that reflects confidence in the past that was already carved out and/or reference to early plans of a balance sheet unwind program could forge gains for the Dollar and perhaps unnerve sentiment trends dependent on the free ride the central banks have offered.
Measuring out trade opportunities on this event, we should consider our market backdrop. Thin liquidity and a deep sense of complacency seem to set the stage for a tepid response. However, such conditions put us at greater potential for surprise. That same lack of preparation is evident in volatility measures. Not only is the equity-based VIX still holding near the decade low set Monday; but we further find the short-term equity volatility measure is extremely deflated as are activity measures on global shares, commodities, emerging markets, Treasuries and more. This sets the threshold very low for surprise, which makes it easier to generate a break on exceptionally narrow ranges like those on the DXY Dollar Index and S&P 500. Further shaping the ultimate response to this event, speculative futures positions behind the VIX, 10-year Treasuries and Russell 2000 all point to considerable anticipation. We break down the full scenarios for this key event risk in today's Trading Video.
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