Macro Wrap – FOMC: Will Rate Timing Change, and What Will Yellen Say? $SPY, $TLT, $UUP

by Enis March 19, 2014 7:45 am • Commentary

As has been par for the course over the past few years, U.S. stock markets have rallied ahead of the FOMC meeting.  The S&P 500 is now less than 1% from all-time highs set in early March, after a 1.75% rally in the first 2 days of this week.

The consensus expectation for the FOMC meeting is for another $10 billion taper, bringing the monthly asset purchase level to $55 billion from $65 billion.  More uncertainty exists around the forward guidance from the Fed.  Goldman Sachs Research summed up their expectations as follows:

Given this backdrop, and under the guidance of Chair Yellen, our US Economics team expects the FOMC to deliver an accommodative message. They will likely acknowledge weather effects, but only partly, in describing current economic conditions and they are likely to continue to taper asset purchase at the current pace. Alongside this, we expect three other shifts that, taken together, are marginally more accommodative. First, the FOMC’s long-run unemployment and funds rate projections may both decline. Second, we expect two participants to move their target dates for the first rate hike (the so-called “dots”) further out. Third, we expect the FOMC to move towards a more qualitative description of the labour market conditions needed to shift to a less accommodative policy stance. This qualitative guidance could occur alongside the current 6.5% unemployment rate threshold or in place of it.

I have read from many other Fed watchers about the expectation for a shift at this meeting from the quantitative “Evans rule” for a 6.5% unemployment threshold to a more qualitative approach given that the unemployment rate has reached the original threshold.  The unemployment rate has declined more quickly than the Fed expected last year, and the Fed does not want to be boxed in by the hawkish implications of the Evans rule.

Among economists, the main uncertainty for today’s meeting is not the $10 billion taper or the change to a qualitative description of the labor market, but rather the forward guidance for the Fed’s first interest rate hike.  Tim Duy, an economist at the University of Oregon, summed up that view in his post yesterday:

The Fed will also update its forecasts – important because ultimately the forecast drives the policy decisions.  I don’t anticipate large changes to the growth or inflation forecasts.  We should see modest downward revisions to the unemployment rate forecast.  What will be more interesting is the impact those changes will have on the interest rate forecast.  The bulk of the FOMC expects the first rate hike will be in the range of mid- to late-2015, with a handful earlier or later.  A lower unemployment rate forecast may prompt some to move up their forecast.  That said, I do not expect large changes in either direction.

A move in the FOMC’s expectation of the first rate hike from mid- to late-2015 to earlier or later would be significant news.  Barring that, I don’t expect any major surprise from today’s meeting.

Heading into the meeting, stocks and Treasuries have rallied, and the dollar has broadly declined vs. the major currencies.  As usual with Fed days, positioning can be as important as the news itself, so the market’s reaction will be quite telling, especially since today will be Janet Yellen’s first formal press conference after a FOMC decision. Meanwhile, VIX spot has not moved below 13.50 since mid-January, even as the S&P 500 index has made new highs.  I’ll be watching that to see whether traders calm down after today’s event.