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Currencies, Equities, Bonds and the FOMC Spotlight

Posted by Joseph Trevisani on Jun 18, 2013 1:08:00 PM

The euro broke through 1.3400 for the first time since February 20th as currency traders anticipate a status quo statement from the Fed tomorrow on the U.S. economy and reassurance from Chairman Bernanke that the central bank will continue its quantitative easing program as long as is warranted.

Credit markets, particularly the Treasuries, have been rife with speculation over the past month that the Fed was preparing to reduce its $85 billion a month in securities purchases as the economy gains strength. Rates on the benchmark 10-year Treasury have risen 55 basis points, from 1.63% at the beginning of May to 2.18% today. They have been as high as 2.23% as bonds have sold off forecasting a Fed policy shift. 

The equity markets, like their currency partners, seem equally secure that the Fed will maintain its easing and keep the buying program at $85 billion a month at least until the end of the year.

How can the Fed offer both economic opinions in one statement and press conference?

Much will depend on the description of the state of the US economy from the Fed and then Mr. Bernanke in the FOMC statement and press conference.

If the economy is described as substantially improved then the credit markets will assume, as they have for several weeks, that the end of the QE program is approaching and interest rates and the dollar could forge higher. If, on the other hand, the Fed stresses impediments and difficulties in the U.S and around the world and the slow pace of improvement, then the end of QE will move further into the future and interest rates and the dollar could weaken.

The Fed's balancing act will be to equally satisfy or dissatisfy both camps.  The Fed does not want to risk an equity crash by implying that the economy is strong enough to withdraw liquidity, but it also does not want to imply that the economy is so weak that it cannot survive without support, sending interest rates plummeting and fear climbing. 

The Fed has two chances to get it right, the FOMC statement at 2:00 pm and Chairman Ben Bernanke's press conference at 2:30 pm.

The economy needs to be improving but not improved, employment should be rising but not recovered and interest rates may be higher but are not a drag on economic growth. Inflation is and will be quiescent.

The most likely outcome for the FOMC statement is little or no change from the last one on May 1st, for the simple reason that a change in the statement implies a change in the economy.

No doubt the Fed Chairman will be watching the market reaction to the FOMC’s verbal gymnastics closely, ready to apply emollients as necessary in person.

Joseph Trevisani

Chief Market Strategist

WorldWideMarkets

Charts: Bloomberg

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