Market Insider

Will Fed Change Its Tune?

The Fed's statement is likely to be uneventful, despite all the buzz about the sinking U.S. dollar.

Traders have been talking about the November Fed statement for days now, because even a subtle tilt in the Fed's posture on interest rates could unhinge the popular "risk on" trade.

That is where investors bet against the U.S. dollar and throw money into risky assets such as stocks and commodities. Ahead of the meeting, the dollar was moving lower, commodities and equities were moving higher, and bond prices were falling, driving yields higher.

Gold has been the most dramatic mover this week. Often seen as a safe-haven play or inflation hedge, gold has soared to record levels as investors bet the Fed will do nothing to stem the dollar's fall.  A large gold purchase by the Indian government also drove prices higher.

"No change of policy is likely. If there are any changes in the language, it's just to give flexibility for when there is a change, so that the comment made now doesn't sound too iron clad," said Pimco senior strategist Tony Crescenzi in a recent interview.


The statement is expected to be released at 2:15 p.m., after the Federal Open Market Committee winds down its second day of meetings. The November meeting is the Fed's second to last of the year, and it is widely anticipated it will do nothing before January, at the earliest.

"It's pretty clear they're not going to pull the trigger this week," said Stephen Stanley, chief economist at RBS. "I don't think they're on the cusp of changing the language because I don't think they have any expectation they are going to be tightening any time soon. We look at that and say it's more of a January proposition, and if you thought they were changing the language in January, then they're maybe moving at mid-year."

The Fed's low-rate policy and the growing U.S. deficit have been weights on the dollar, but the low rate environment has also helped to reflate the stock market.

Crescenzi, in a note, said the Fed should indicate more specifically the type of economic and financial conditions that would justify the current language that it sees "exceptionally low levels of the federal funds rate for an extended period." If it were to do that, investors would have a better idea of what would determine a change in policy and would respond incrementally to changing economic conditions rather than suddenly to a shift in the Fed policy statement.

"The market is very sensitive to even modest changes in the wording. You can see how nervous people are by looking at the short end of the (Treasury) curve," said Marc Chandler, head currency strategist at Brown Brothers Harriman.

The target Fed funds rate has been at zero to 0.25 percent, and the part of the Fed statement traders have focused on is the part that says the Fed will keep rates low for an "extended period."

"If they dropped that extended period, I think the dollar would react positively even if the stock market sells off," said Chandler.

Economists say the Fed is likely to acknowledge an improved economic outlook, but it is watching for a turn in the employment picture before it changes its stance. The next good look at the jobs situation is Friday, when the government releases its October employment report.

Even if it doesn't alter its statement, Fed committee members are expected to spend time discussing change, which will make the minutes of the meeting important to markets when they are released next month.

"There's this massive chasm at the FOMC between the hawks and the doves. Maybe more than I've ever seen. I think these policy debates are the right word. But there is some pretty substantive disagreement among the committee members about where we are and where we're likely to be headed," Stanley said.

Other Moves the Fed Could Make

Traders look to the Fed to make other moves that could push rates higher. For instance, traders believe the Fed could carry out reverse repos which would be a way to move rates higher without changing the target Fed funds rate. They also look to the Fed to withdraw its quantitative easing over the next couple of months.

Already, the Fed wound down last week its $300 billion program to buy Treasurys. It plans to discontinue its program to buy $1.25 trillion in mortgage backed securities in March.

"December of last year is when they contemplated buying Treasurys," said Cantor Fitzgerald Treasury strategist George Goncalves.

"We've come full circle. I don't think they'll do anything major now or in December and we'll see how the payroll numbers come, now and in December," said Goncalves.

He said a bigger story for the Treasury market Wednesday could actually be the refunding announcement from Treasury. "Tomorrow's a bigger day for the Treasury market than some other markets. You'll get some insight into where the Treasury's head is at," he said. The Treasury is expected to hold auctions of TIPS and 3-, 10- and 30-year notes next week.

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Chandler said the dollar has been moving higher not because of new long positions but because investors are reducing shorts. He said one thing they making the market nervous is the European Central Bank meeting Thursday, where the ECB could signal an end to a bank lending program that allows banks to borrow an unlimited amount of money at 1 percent for a year. That could strengthen the euro.

Wednesday Earnings