After months of speculation, the Fed will finally announce its monetary policy plans for the month of September! Aside from keeping its rates steady between 0.00% to 0.25%, market junkies generally expect the Fed to start tapering its monthly asset purchases.
Don’t be blinded by just the asset purchases though. After all, with the “Septaper” issue making the headlines for months, any tapering decision might already be priced in. With that, you should also look at these four factors that might influence the dollar’s price action:
1. Economic Forecasts
Aside from its monetary policy decision, the Fed will also talk about its growth and inflation estimates. Lower growth forecasts could offset any decision to taper as it would hint that the Fed isn’t too confident about the economy after all. In fact, continued pessimism over the economy could even urge the Fed to “untaper the taper” and add back to its asset purchases!
2. Forward Guidance
In order to emphasize that tapering is NOT tightening, the Fed would need to be careful with its words regarding its future plans. As it is, Bernanke will most likely use the opportunity to manage market expectations by saying that the Fed would keep its low interest rates in the foreseeable future.
The Fed could also reiterate that it’s not discounting the option of adding back its asset purchases. This cautiousness should be helpful in keeping bond yields in check and preventing long-term interest rates from spiking.
3. Treasury Bonds vs. Mortgage-backed Securities
The go-signal on tapering is just one of the many things that Fed officials will have to decide on today. Should they push through with the Septaper, they also have to think about exactly how much they will reduce in purchases of Treasury bonds and of mortgage-backed securities.
A $15 billion combined reduction in bond purchases might be split into $5 billion in Treasuries and $10 billion in mortgage-backed securities or vice versa. How the Fed gets creative with its taper breakdown could provide clues on how policymakers think the bond market or housing sector will fare. In other words, a larger reduction in mortgage-backed securities might reflect stronger confidence in the housing recovery.
4. Future Taper Schedule
Should the Fed decide to hold off tapering, Bernanke might still provide a schedule for when it plans to reduce bond purchases. After all, the Fed has been known to sit on its hands when economic conditions are not that stable yet. Take note though that saving the taper decision for October might be complicated because of the debt ceiling vote while a December decision might be tricky prior to Bernanke stepping down.
In any case, stay on your toes for potential volatility during the actual event. The dollar could have a pronounced reaction to parts of Bernanke’s speech, as traders scramble to interpret what it could mean for monetary policy and the dollar.
If you’re not ready for this kind of price action, better stay on the sidelines and observe. Instead of immediately reacting to the statement, take this time to digest what the Fed’s clues could imply for the dollar moving forward.