Despite a change in policy stance being extremely unlikely today, the FOMC announcement is going to be tracked extremely closely by investors and could drive large amounts of market volatility.
Investors have been debating for months about the timing of the first rate hike from the Federal Reserve and whether it will come this year or next. The main argument against a rate hike this year is that inflation is currently below target and we’re not seeing the kind of spending from consumers to be confident of future price increases.
The argument for assumes that with good wage growth, low unemployment and less slack in the economy, price inflation will naturally follow. With that in mind, a rate hike this year and a more gradual pace of hikes in the future is less of a threat than potentially having to hike them at a faster pace next year. For a long time now, the Fed has appeared to be in this camp.
Given that it has been in this camp for most of the year, even during the first four months of the year when the U.S. economy was suffering under the weight of the strong dollar, poor weather and tumbling energy prices, it will be a shock if it changes course now. With no press conference scheduled following the decision, the statement that is released alongside it will be of even more importance.
Any changes in the Fed’s language will be heavily scrutinized for clues on whether the first hike could come at the next meeting in September. Naturally, different people will interpret the data very differently, probably dependent on their own bias and the result is big market swings and huge volatility. Especially given the proximity to the potential lift-off date.
It’s quite rare that the language is crystal clear to the point that people interpret it in one way and even if this is the case, the reaction in the markets would be large. The chances are the language will be largely the same as in previous statements, as will the caveat being the data dependency.
There are a few particular terms that investors will scrutinize more closely, most notably those relating to inflation and the labour market, which makes up its dual mandate. Last month the Fed suggested that the underutilisation in the labour market had diminished and oil prices stabilized, having previously acted as a drag on inflation. If the rhetoric remains the same then September is very much on the table.
If the statement focuses more on the pace of future rate hikes rather than the first, that would also suggest that they are looking to hike in September and contain any market panic. Whatever happens, volatility is expected and many different asset classes may be impacted from Treasuries to the dollar to commodities, particularly gold tends to suffer in times of monetary tightening.
The S&P 500 is expected to open 2 points higher, the Dow 3 points lower and the NASDAQ 9 points higher.