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Federal Reserve officials are virtually certain to hold interest rates steady when their meeting ends today but they could try to send a message to markets and outside observers about what likely comes next. With no press conference scheduled after this week’s meeting and no new economic forecasts to be released, all the attention will be focused on their words and the market is more aware than ever that the Fed doesn’t act in a vacuum. As Bloomberg’s Richard Breslow notes, The Fed is hopeful (that their always-wrong forecasts come true this time) but they’re also scared to death on the consequences.

Bloomberg’s Mark Cudmore notes that while Fed monetary policy may not change today, any shift in wording from last month’s statement may have massive consequences.

The recent divergence of U.S. rates and the U.S. dollar implies the future path for global assets is increasingly binary.

 

U.S. financial conditions are now easier than they were at the time of the December rate hike and challenging the two- year trend of tightening. Any dovish signal today would provide yet another significant reflationary impulse to global asset prices

 

Emerging market assets have paused recently and may be the biggest beneficiaries of such an outcome

 

On the flip-side, if the statement (there’s no press conference scheduled today, so this is the only insight investors will be getting) indicates a summer rate rise is likely, the Bloomberg Dollar Index will smash the three- month downtrend and lead to a significant re-tightening of financial conditions.

 

 

The knock-on effects could be spectacular. Speculative positioning is now net short the dollar for the first time since July 2014, according to the most recent CFTC report.The Bloomberg Commodity Index is up 9% in the last three weeks alone

 

The market is more aware than ever that the Fed doesn’t act in a vacuum.

  1. There’s an argument that increased easing from the BOJ and ECB prevents tightening in the U.S. because excessive policy divergence will make the dollar too strong
  2. Alternatively, as other central banks provide more stimulus to the global economy, the impact of any Fed tightening outside the U.S. might be mitigated to some extent
  3. Perhaps there’s a third path? A Fed statement so dovish that it provides an inflationary boost strong enough to force the central bank into a summer rate hike

Deutsch Bank agrees that, with no press conference, all the focus will be on the tone of the associated statement.

The Fed will want to leave the door open for a June hike but it’s hard to imagine that they’ll dramatically change market pricing for it.

 

The futures contracts have nudged up to pricing a 22% probability of a June hikefrom as low as 14% mid-way through this month. How much this changes will likely hinge on what extent the Fed continues to acknowledge concerns about global growth and risks abroad. US data has been mixed of late. After getting back close to neutral at the start of April, economic surprise indices have trended steadily lower into negative territory as the month has passed.

 

On the positive side the weaker US Dollar should give the Fed some confidence.Since the March Fed meeting, the Dollar index has weakened just over 2%. That’s partly helped to support a near $8/bbl gain for WTI and 4% rally for the S&P 500 to YTD highs. We think much of the rebound in markets since early February has been due to the Fed’s about turn and re-found dovishness.

 

This leaves them trapped in our opinion.

So, as Bloomberg’s Richard Breslow writes, it’s best to just play it straight…

The Fed is hopeful. They’re also scared to death. The track record of official forecasts has been, shall we say, less than stellar, making “looking through data” a questionable strategy. And communication policy is still very much a work in progress.

 

An attempt at nuance could very well end up with the markets misinterpreting the intended message. And it won’t be helpful to get another set of speeches decrying that traders got it wrong

 

The numbers don’t argue for a hawkish statement. They also don’t worry over a rate volte face. They do suggest that the Fed should sit this statement out. Are all meetings live? Yes. It’s just another meaningless phrase

 

Employment growth has been strong. Not so much wages. Inflation remains below target. GDP and PCE deflator Friday are both expected to be sobering events, after a string of weak data

 

It’d be a hard sell to tell the country that the numbers are mostly rubbish but we need to get that jobs growth under control

 

A lot has been made of the recent “back-up” in Treasury yields. To where? Exactly the level they closed on the day of the very dovish March meeting.

 

 

It’s not a coincidence that a number of serious bond investors are initiating new longs here

 

I know they wish they could hike away. I get the frustration with the world being too much with us. But that’s reality

 

Japan’s in such a mess that analysts are seriously discussing what debt monetization would mean. China’s numbers have been unquestionably better but not without continued stimulus, which is proving to be necessary but not sufficient. After today’s negative CPI, Australia is firmly a rate cut candidate

It’s only weeks since Chair Yellen was incontrovertibly dovish. Equity bubbles can change that fast, but the global economy can’t.

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