Preview of the FOMC Meeting: Balance Sheet Run-off Announcement is the key Thing to Watch


The Fed is expected to deliver a 50 bp rate hike today and announce the start balance sheet runoff. Markets will be interested in the pace of QT, since this will determine supply of longer-maturity Treasuries on the market in the medium-term which has a great influence on greenback demand. For example, the pullback of 10-year Treasury yields from 3% to 2.92% caused dollar sell-off on Tuesday and also helped EURUSD and GBPUSD to defend critical support levels – 1.05 and 1.25. The pairs continue to stay range-bound ahead of the FOMC meeting:Such dynamics suggests that the pairs could finally choose direction after the Fed meeting, which is unlikely to be limited to one session, since significance of the Fed meeting in May is high. Firstly, the macroeconomic background has changed significantly, it became clear that high inflation will last longer than previously thought, and secondly, a plan to reduce assets from the balance sheet will be made public. This monetary tool, given the amount of funds on the Fed’s balance sheet, which is at a record level and amounts to almost $9 tn, will have serious consequences for the US fixed income market:The Fed accumulated on its balance sheet mainly long-term bonds and MBS which means that balance sheet runoff will primarily impact the far end of the yield curve (the aggregate of interest rates on bonds depending on the maturity). The dollar is known to be the most sensitive to the movements of long-term bonds yields so the dollar may respond significantly to the balance sheet decision. A short-term breakout in EURUSD, GBPUSD below 1.05 and 1.25 cannot be ruled out if the Fed simultaneously raises rates by 50 bp and chooses aggressive pace of selling assets, as this will leave the central banks of the EU and the UK further behind in the race to tighten monetary policies. If the rate of balance sheet reduction comes below consensus ($50 billion per month), it will most likely be difficult for greenback to advance to new highs, as the bar for a market surprise is high.Admittedly, the Fed has plenty of room to act aggressively, with the number of new US job openings reaching a new record high of 11.266 million:It is clear that there is a serious shortage of workers in the United States, which will likely continue to translate into robust wage growth, and hence consumer inflation, since wages are both the costs of firms, which are passed onto final prices, and the basis of consumer demand, which also determines price growth in an economy.The ADP report released today was somewhat disappointing – job growth amounted to only 247K against the forecast of 395K. However, given the record high number of open vacancies, the data may be interpreted as another signal that employers could not find workers and most likely this was reflected in the growth of wages, which the NFP will tell us on Friday.During the Fed meeting, the market may also implement the “sell the facts” strategy, this must be taken into account because the markets have probably price in incoming information on inflation, labor market, activity in the manufacturing and services sectors, as well as external supply shocks. A continuation of the dollar rally will likely require shocking Fed action, such as a 75bp rate hike, which is unlikely to happen.Retail sales in the Eurozone in April did not live up to expectations, growth amounted to only 0.8% in annual terms against 1.4% forecast. Such dynamics complicate the task for the ECB to move to raise rates, but some officials are in favor of a July hike. Nevertheless, the centrists from the Governing Council are silent, therefore, serious catalysts for the growth of the Euro from the ECB, at least until the June meeting, are not expected.

Source: Tickmill

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