Markets expect hawkish Fed outcome
Nerves are still raw after the heightened volatility that has played out across global equities in recent weeks, as markets anxiously await the next set of policy clues out of today’s FOMC meeting.
US futures are trying to keep their chin up after the VIX index spiked back above 20, its long-term average, during Tuesday’s tech-led declines for US benchmark indices. The market tension is also keeping the Dollar Index elevated in the mid-96 region, which in turn is suppressing spot gold below the psychologically important $1800 level. Asian stocks are mixed with risk sentiment further dented by concerns that China’s property sector could be a bigger drag on headline growth next year.
Fed set for faster tapering
The bar has been set high for a hawkish surprise out of the FOMC meeting. Market participants have had plenty of time to digest Fed Chair Powell’s shift in his inflation outlook, having recently ditched his “transitory” stance. Tuesday’s release of US producer prices in November was the latest in a series of sobering reminders that the Fed may have to act faster than initially intended, likely resulting in a more condensed tapering timeline that opens the door for the first US rate hikes since the pandemic.
Nevertheless, investors and traders are set to pore over every clue contained within Chair Powell’s press conference, the FOMC statement, new economic forecasts and the dot plot. Should market participants discover an even more hawkish bias within the FOMC than what’s already priced in, such signals could give fresh legs for dollar bulls, while triggering fresh declines for spot gold and overvalued growth stocks.
Policy divergence across the Atlantic
The Fed will set the policy tone for all other central banks to follow, with the ECB and the BOE next off the conveyer belt of key decisions this week. Overall, policymakers have a delicate balancing act between leaving enough policy flexibility to accommodate Omicron risks, while also needing to get a firm grip on surging consumer prices.
While the Fed is set to lean hawkish, the ECB and the BOE could be forced to maintain a relatively dovish stance considering the persistent pandemic concerns. This projected policy divergence is likely to keep the euro and the pound on the defensive versus the greenback.
However, this also means that the bar is lower for a hawkish surprise on that side of the pond. Should markets perceive either the ECB or the BOE to be less dovish than thought, that could prompt a rebound in EURUSD and GBPUSD. Overall, the Fed’s expected hawkish inclinations are likely to translate into strong support for the US dollar and it should have little qualms climbing higher if markets price in even more Fed rate hikes for 2022.