Traders Cautious Ahead of FOMC

I expect to see an element of caution in the markets on Wednesday as investors look towards to latest FOMC interest rate decision and accompanying releases and press conference for insight into when they will raise interest rates.

The Federal Reserve has not hiked interest rates in nine years and while many other central banks around the world are likely to loosen monetary policy this year, the U.S. economy is on a much firmer footing and a rate increase in September looks very likely. A slow start to the year looked to have potentially derailed the prospect of a rate hike this year but a strong batch of economic data in May, most notably wages and retail sales, has added credence to the Fed’s view that the January to April period was just transitory.

While we could technically see a rate hike today, and many at the start of the year thought we would, it is now very unlikely as the May rebound could simply be a false dawn. The Fed will want to be very cautious when it comes to the first hike following such a prolonged economic slump, especially when other central banks are doing the opposite which in itself adds deflationary pressures to the U.S.. I think they’ll want to see three months of good figures that point towards future inflationary pressures before they act.

Some still believe that September, or even this year, would be too early but the problem with this view is that the Fed intends to raise rates slowly in order to avoid any shocks to the economy following such a long period of low rates. The longer they put off the first rate hike, the more they risk having to hike rates faster in order to combat higher inflation which would be expected when the economy is getting stronger. This would provide a much greater threat to the economy that an earlier hike and slower path of increases thereafter.

As well as the FOMC decision on interest rates, we’ll also get the accompanying statement, the latest dot plot containing interest rate forecasts from the FOMC policy makers and a press conference with Chair Janet Yellen. Needless to say, each of these has the potential to bring considerable volatility to the markets and I fully expect it to. We may have seen yields on US 10-year Treasuries rise significantly in recent months but this hasn’t been matched by rises in the dollar, which suggests it has been driven by rising European bond yields, rather that interest rate expectations.

The dollar is still well off the highs of the middle of March and April and the dollar index has actually trended lower since the May figures have been released. This suggests to me that there is plenty of upside available in the dollar if the FOMC is deemed to be hawkish, especially if hints of a September rate hike are dropped, which I believe they will be.

The S&P is expected to open 6 points higher, the Dow 54 points higher and the Nasdaq 11 points higher.

For a look at all of today’s economic events, check out our economic calendar.

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