FOMC and the FED – Make or break scenario for financial markets
Market Update – 17th March 2021
Over the past couple of weeks we have highlighted on a number of occasions the rise in bond yields, and the threat they pose to financial markets.
Everyone knew at some point this year that bond yields would rise, so what has all the fuss been about?
The move higher has not necessarily been the issue, it is the speed at which the interest on the yields has risen. The sharp rise in interest rates on the 10 year has resulted in volatility spilling over into risk assets. Especially tech growth stocks. Stocks like Tesla, Apple and Amazon have been hit the hardest, as they were the corporations that benefited the most during the economic downturn.
The rise in interest rates on bond yields signals a strengthening of the US economy. Markets are beginning to price in an interest rate rise or a bond tapering (central bank tightening) from the FED a lot sooner rather than later. Growth stocks surged throughout 2020 and early 2021 anticipating further stimulus and record low-interest rates for the foreseeable future. However, this could be coming to an end…
“The steepening yield curve reflects that returns on long-term bonds are growing faster than the return on short-term bonds, signalling economic optimism. This indicates the spread between short-term and long-term interest rates has widened. When a yield curve is steep, the market is pricing in central bank tightening. This means that the market believes the central bank will increase short-term rates, eventually creating a normal yield curve at higher short term rates.”
Will rates continue rising?
Back in 2016, the FED announced they were reducing the pace of its purchases of treasury bonds (bond tapering), to reduce the amount of money it was feeding into the economy. The market did NOT like this, resulting in equties sinking lower. This is now known as the 2016 taper tantrum. A similar scenario is potentially on the cards at some point in the near future. The question is will it occur during the next meeting.
FOMC DOT PLOT & Interest Rate decision
The FED will release their new economic and interest rate forecast, which could show FED officials expectations to raise interest rates by 2023 which is sooner than the market expected, 2024. If so, expect a bearish move across risk assets and a bullish move on the USD.
Scenario 1: Potential Dovish Outcome (weaker USD)
FED members signal yield curve control intervention. This is where the FED will purchase bonds on the longer end of the yield curve to drive interest rates lower.
DOT Plot remains unchanged. This is where FED members signal their opinion on interest rates over the next two/three years. If this remains unchanged expect a weaker USD. Currently, the DOT plot median is a possible rate hike by 2024.
Scenario 2: Potential Hawkish Outcome (stronger USD)
If FED Chair Jerome Powell has no verbal intervention on the bond yields.
If the DOT PLOT median interest rate change moves closer, from 2024 to 2023.
No announcement of yield curve control.
USD INDEX – Daily Charts
There are two key levels to keep a close eye on. A close beneath the 91.36 support will indicate a continuation to the downside. This may occur if the FED cools inflation and interest rate fears. However, a breakout above the new resistance at 92.70 will indicate a continuation to the upside. This will occur if the FED signals an interest rate hike sooner than market consensus.
As always we will be looking to capitalise on the volatility in the trading floor later this evening! If you have any questions let us know in the trading floor live chat.