Every time we've had one of these meetings this year, it's felt like I've said it's going to be the most important meeting of the year.
This time, financial market participants are waiting to see if the Fed will decide to increase the pace of its asset purchases from USD15bn/month. The consensus currently is that the Fed will decide to double the pace of tapering. There are a number of reasons for this. Firstly, inflation continues to climb higher (as in the chart below) and a growing number of Fed officials are beginning to express greater concerns.
Source: Refinitiv
Secondly, now that Powell is secure in the job and his reappointment has been confirmed, he may feel more secure in taking a slightly more hawkish stance. I don't believe this to be true, but that's what some people believe.
Source: Refinitiv
The chart above shows quite an interesting picture with yields. On the one hand, the 2y yield has climbed pretty rapidly higher to around 0.8%, however, the 10y yield and the 30y yield have both come down quite significantly too. To me, this is indicative that the market thinks the Fed will act fast and then probably have to bring rates back down again to support the economy.
It's very obvious that as debt levels around the world have mounted through the pandemic, economies will be less able to support higher levels of interest rates. Thus, I believe there is a potentially very profitable trade involving a short position in the 10y Treasury, and a long position in the 2y Treasury. I'd like to see the 10y move back to around 1.8-2%, and the 2y to drop to around 0.5%.
What's Luke's Call?
Personally, I think there has been enough evidence recently for the Fed to hold off increasing the pace for another meeting. We have the Omicron variant, the inflation report Friday wasn't as bad as many market participants were expecting, and some of the commodity price pressures are now abating. There is a lot of evidence to suggest that the inflation numbers could now start to drop gradually, but persistently in the coming months.
Likewise, some US states have started to take actions to try and combat the spread of Omicron. To me, this clearly shows that the Fed will need to be reactive to possible slowdowns in the economy once again and should leave the additional policy support in place for another month.
Either way, the market seems pretty confidence in a doubling in the pace of asset purchases. Therefore, What's The Trade?
The trade for me this time is pretty obvious, get short the USD this week. It's an asymmetric risk in my opinion - either the Fed acts, which the market expects, and increases the taper pace, the USD flatlines. Or, the Fed doesn't act, and the USD gets significantly weaker. I'd be looking to short directly via some of the risk pairs - buying AUDUSD seems like a nice option. (I also like this trade due to the undervalued nature of the AUD at the moment so it's a win win!).
Source: MT5 FxPro
I like the idea of playing the 50% retracement from highs to lows on the chart above. You can see that we have now moved out of that aggressive downtrend, so I think this is definitely a good buying opportunity.
Either way, I think this is a Fed meeting well worth watching and trading. Please do reach out with your questions.
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