Why Fed decision could mostly hinge on one word

Summary

Markets are betting on an awkward word.

Snoozefest alert

The probability of a 25 basis-point Fed rate rise tonight is 95% baked in, according to Fund futures implied probability. But markets have also mostly priced another hike in December, whilst in 2019, two further rises are on most investors’ radar. Even three would not be a shock. That suggests the decision, statement and press conference could be a snoozefest. However, the fate of one word could still ignite market volatility.

Dot plot can wait

This time around, markets may be more interested in the policy statement than any other Fed communication. That’s partly because, on balance, economists perceive lower probabilities for changes in FOMC rate forecasts (‘the dot plot’). For these to occur, FOMC members would have to be confident already that an additional 2019 hike, likely in December, is imperative. That date is more than a year away. It’s reasonable to assume most policymakers will wait till the first spring meeting, at the earliest to decide. As for the press conference with chair Jerome Powell, live commentaries from Fed chairs are notoriously unreliable indicators of future policy intentions. All this leaves the policy statement as the best indicator of any changes in FOMC thinking that may be brewing.

Less accommodation eyed

Within the statement, market thinking has zeroed in on a single word present in a long stretch of recent statements – “accommodative”. In fact, it has been used within a sentence, as per August’s statement: “The stance of monetary policy remains accommodative, thereby supporting strong labor market conditions and a sustained return to 2 percent inflation.” Since the phrase strongly suggests rate hikes have latterly been made to support the economy, switching the word “accommodative” for another, or qualifying it with an adjective like “somewhat” would telegraph a new interpretation of policymakers’ intent. So, watch for such a change, or a qualifier, that magnifies its strength. Markets would interpret that as more hawkish, probably triggering sizeable moves by the dollar (gains), U.S. stock markets (losses) and Treasurys (yields would rise). If the Fed’s statement changes in more subtle ways, and no strong hints about an even steeper rate path are forthcoming in the Fed chair’s press conference, or FOMC members’ dot plot, that would be a de facto dovish outcome. On balance, that would favour riskier assets in the short term. It would certainly put immediate pressure on the dollar whilst giving other major currencies, like the euro and sterling, a fillip.