There has been a lot of speculation about what the FOMC could decide at their two-day rate decision meeting which ends tomorrow.
Interest rates, as expected, are likely to remain the same.
However, there has been a lot of talk regarding the potential new policies that the Fed could introduce. Especially after Powell’s comments at Jackson Hole!
Is it Time for an Average Inflation Target?
There is a pretty firm consensus that in the statement accompanying the rate decision, the FOMC will change their inflation target language.
The current version is “symmetric 2% inflation objective”. And it’s likely to read something along the lines of inflation averaging over 2% over time. This is in line with formally adopting the new inflation target as we’ve described previously.
This point is likely to get a substantial amount of media coverage. However, it probably won’t influence the market all that much since it’s mostly priced in.
What could jolt the dollar stronger is if the Fed doesn’t formalize this policy at this meeting.
So, Eventfully Uneventful?
Generally, the Fed doesn’t like to roll out more than one policy change at a time. Unless it’s an emergency, that is.
Mostly this is to gauge the market reaction and adjust accordingly. However, this naturally opens the door for speculation about what the next measure the FOMC will take. And this, in turn, can also move the market.
Given the expectation of the new target policy, it’s generally assumed that the dot plot and forward guidance of asset purchase will remain the same.
Fed officials have said so far that there is no urgency to adjust the balance sheet policy.
Coming Up After This…
However, we expect this to be the next thing that the Fed will tweak. Therefore, the market will probably be extra interested in anything that might be interpreted as a potential change in policy.
There is an increasing consensus that the November meeting will include a change in the asset purchase guidance.
So, be on the lookout in the press conference afterward. Reporters are likely to ask Chairman Powell about asset purchases.
Depending on how he words his response, we could get some fluctuations in the dollar. If the hint is that November is too early to consider cutting back on asset purchases, we could see dollar weakness.
If Powell changes the current rhetoric – that it’s not necessary to consider yet – then it could strengthen the dollar.
What if the Fed Doesn’t Announce a Policy Change?
The market will be taken by surprise if that happens, so it’s useful to have a contingency plan.
No new inflation target will likely be interpreted as hawkish. The new target allows for higher inflation, meaning that easing will continue for longer. Therefore, we’d expect the stock market to take a hit and a stronger dollar.
Politics can have some bleed-over effect here, as the lack of government action prompts the Fed to take the lead in supporting the recovery with monetary policy.
On the other hand, the latest data has shown a much better economic position than at the last meeting, with the recovery continuing to accelerate. Likely not enough to change the policy, but might be enough to change the tone of the Fed to be more optimistic, and could, ironically, weaken stocks.