The Fed is widely expected to conclude its QE3 asset purchases program, with the final taper of the remaining $15 bn. Since there is no post-meeting press conference scheduled for today, the Fed will ensure to highlight the dovish advantages of highlighting low inflation and prolonged rates for a prolonged period. A new high in equity indices is inevitable this year, but the peak may not extend further than 5% above the September high.
Speed and timing
In addition to reaffirming the continuous reinvestment of proceeds from purchased assets, the Fed will draw attention to the wording on the timing and speed of interest rate hikes in function of the pace of progress in labour markets and inflation nearing 2%. Most observers will watch whether the Fed will keep “considerable time” wording in reference to low interest rates, in which case would help weigh on the US dollar if maintained word for word. There is a possibility that the phrase would be edited to read “for some time”, in order to achieve the simultaneous task of changing the statement, while maintaining the same vagueness. And since Fed vice chair Stanley Fischer said “considerable time” could mean anytime from two months to one year, markets will take it to mean that that the subjectivity of “data dependence” shall continue to rule the next 7-9 months.
Considerable time and low inflation vs. ending QE3 and robust jobs
Any hawkishness & USD positivity caused by the Fed’s confirmation of ending QE3 and upgrading its labour market assessment in today’s statement will likely be offset by the renewed emphasis on persistently low inflation and rehashing of the prolonging of low interest rates.
Although the absence of a post-meeting press conference will spare markets from any additional over-analysis of the dots forecasts on the timing of the first rate hike, price whipsaws are inevitable in the ensuing 30-60 mins.
Filling the gap between Fed policies
The chart below reminds us that the stock market, as measured by the S&P500 consistently fell by more than 15% between the conclusion of the Fed stimulus programs; between the end of QE1 and start of QE2; and between the end of QE2 & start of Operation Twist. Interestingly, Operation Twist (OT), which started in September 2011 was supposed to have ended in June 2012, but the market turbulence of summer 2012 forced the Fed to delay the expiration of OT to December 2012. This means that both QE3 and OT functioned simultaneously during September-December 2012, shortening the duration of the usual inter-period selloff, but the magnitude of the market corection.
Looking ahead, assuming no surprises from the Fed today, the end of QE3 will likely be cushioned by some market-friendly language, whose effect is likely to last into the December FOMC meeting, until the next judgment from data dependence takes over. Short of any new programs, a correction of at least 15% would be inevitable.
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