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Why this might be 2014's most pivotal week for financial releases

Part 2
Why this might be 2014's most pivotal week for financial releases (Part 2 of 7)

April FOMC: Are you ready for clues of the Fed’s new guidance?

The April FOMC

This week, the Fed’s third Federal Open Market Committee (or FOMC) meeting of the year will be held on April 29–30. Always a market-moving event, the meeting announcement is expected on Wednesday, April 30.

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Highlights of the Fed’s FOMC meeting in March

The Fed’s taper of monthly bond purchases continues at “measured pace.” The Fed announced a further reduction in its monthly bond purchases by $10 billion per month, with purchases of longer-term Treasuries (TLT) and agency-backed securities (MBB) reduced to $30 billion and $25 billion per month, respectively.

The Fed’s forward guidance on future monetary policy changes

The Fed also changed the form of the forward guidance it would provide to markets—from quantitative to qualitative. This means the Fed will no longer provide quantitative thresholds as triggers for determining the future increases in the Fed funds rate. Earlier, the Fed had specified an unemployment rate target of 6.5% as a trigger for raising the base rate. This target would no longer apply, as the unemployment rate had already reached 6.6% in January. The Fed would now use a host of indicators for determining base rate changes, taking “into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments.”

For more on the Fed’s new forward guidance policies, please read the Market Realist article Will forward guidance after the taper ends be Delphic or Odyssean?

FOMC members provide the “dots” for the base rate guidance

At the Fed’s March FOMC meeting, the 16 members of the FOMC provided individual forecasts on when they expected the Fed Funds rate to rise and by how many basis points (or bps). Of the 16 FOMC members, 14 estimated a rate hike by 2015. Fed officials also revised their forecast for the median rate at the end of 2015 to 1% from 0.75%.

These “dots” had a profound impact on both stock (IVV) and bond (TLT) markets, which slumped after the guidance was announced. This is because markets expected the base rate to rise much later. Fed Chair Janet Yellen, in a press conference after the FOMC, said she expected the base rate to rise around six months after tapering ends. Going at the current pace, tapering is expected in the fall. This would mean the base rate was expected to rise sometime after spring 2015.

The iShares Core S&P 500 ETF (IVV), which tracks the S&P 500 Index, was down ~0.5% on March 19. IVV components Exxon Mobil (XOM) and Chevron Corp. (CVX) fell ~1% and ~0.9%, respectively. Both Exxon Mobil (XOM) and Chevron Corp. (CVX) will declare earnings this week, on May 1 and May 2, respectively.

Bond markets (HYG) didn’t escape unscathed. ETFs like the iShares 20+ Year Treasury Bond ETF (TLT), which invests in long-term Treasuries, and the Vanguard Total Bond Market ETF (BND), which invests in investment-grade U.S. bonds, were down ~0.8% and ~0.5%, respectively, following the Fed’s announcement. The iShares iBoxx $ High Yield Corporate Bond ETF (HYG) was down ~0.5%.

A revision in quarterly economic estimates

The Fed also released revised central forecasts (or mid-point estimates taking all the FOMC members’ views into account) for economic variables:

  • GDP forecast for 2014 was revised downwards from 3.0%–3.5% in December 2013 to 2.9%–3.4% in March 2014
  • The unemployment rate forecast for 2014 was revised downwards from 6.8%–7.3% in December 2013 to 6.7%–7.0% in March 2014
  • Core PCE inflation, or inflation excluding the volatile components of food and energy, was revised slightly upwards, to 1.7%–2.0% in March 2014 from 1.6%–2.0% in December 2013

Outlook

The Fed is widely expected to continue with its tapering of asset purchases, as economic releases in the manufacturing sector have shown improvement and the labor market also looks to be slowly recovering. As there has been no significant setback to the economy, the monthly level of asset purchases should come down from $55 billion per month to $45 billion per month.

To read about the key economic releases due on Monday, April 28, please continue to Part 3 of this series.

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