US Dollar: Rally or Collapse Depends on FOMC’s Risk

WASHINGTON (Sept 18)  We have finally reached one of the most talked-about event risks in months, and expectations for its impact range from ‘non-event’ to explosive volatility. One thing that traders should appreciate: regardless of immediate volatility, this event will have trend implications. The September Federal Open Market Committee (FOMC) meeting has been pegged as the policy gathering at which the central bank would embark on its effort to rein in its expansive stimulus program – now commonly referred to as the Taper – since Chairman Bernanke laid out a time frame back in June. In the press conference that followed the June 19 rate decision, the captain of the largest stimulus program in history announced that he expected to being reducing the $85 billion -per-month QE3 program ‘later in 2013’ and possibly end it by ‘mid-2014’.

Simple deduction has led the market to its consensus that the first move to moderate would come today. Considering the policy authority wants to progress at a moderate pace in its wind down to mid-2014, that Bernanke is expected to retire in January and the best opportunity to ‘explain’ the move comes during the quarterly meetings (the next is December); September ultimately seems the most reasonable time for a move. As an alternative scenario, though, no Taper would trigger a considerable backtrack on months of adjustment that would be felt most fully in Treasuries and the dollar. The current debate no revolves around how large the cut will be and the pace thereafter.

While there are contradictory reads on what the market expects between an 85 percent rally in 10-year Treasury yields and record highs for US equity markets, expectations are likely to mirror the consensus amongst economists. According to Bloomberg’s poll of the group, the central bank is prepared to lower its monthly dip by $5 to $10 billion . From there, we have a benchmark for the event’s ‘surprise quotient’. If the group decides to cull more to the tune of $15 billion or higher (the New York Fed’s Primary Dealer survey projected this figure), a considerable portion of the market will likely need to reposition.

While the first Taper is absorbed and the market gains a clearer view of the central bank’s future pace of policy, the focus for traders looking for the heaviest market impact must be on this event’s influence over risk trends. While we have seen the market’s effort to discount the stimulus turn range from extreme (with Treasuries) to more modest (as with the dollar), the benchmark for risk appetite – the S&P 500 – has defied correction. For a market built on record amounts of leverage, a cooling economic backdrop and flimsy investor participations; this important barometer is extremely exposed. Conditions are ideal for a deleveraging that exposes the broader financial system to risk aversion. It is important to recognize that the initial reaction may be blurred and volatility stunted, but don’t underestimate its implications.

British Pound will US BoE Minutes to Compare UK to US Policy

According to the August CPI figures, inflation pressures have cooled in the UK . Yet, that doesn’t seem to have curbed the market’s expectations of rate hikes. Looking at forward rates and government bond yields, we find investors rebuffing Bank of England Governor Mark Carney’s vow to hold rates at their exceptionally low levels through 2016. In today’s London session, the MPC will attempt to reassert their commitment to low rates to help encourage growth through the BoE minutes. Yet, it will be difficult to shake the consensus rate forecast – and the Fed focus.