Summary:

• Balance sheet normalization expected today but it’s dot-plot that could be crucial
• EURUSD ahead of the key pivot point – will it be broken?
• FOMC decision at 7pm BST, Yellen starts her conference 30 minutes later

The FOMC meeting is the key event of the week and it is little surprising that investors await a decision at 7pm BST and the conference of Janet Yellen 30 minutes later. Here are the 3 things you need to watch for:

Balance sheet normalization

The Fed hikes rates in March and June and this time it’s expected to announce plans to reduce its massive balance sheet of $4.5 trillion. The Fed will not be actively selling bonds but stop reinvesting some inflows from this portfolio. The Fed will forgo reinvestment of $6 billion of Treasuries per month and $4 billion of mortgage-backed securities, so we are talking about $10 billion reduction per month. This is a lot of money but not when you compare it to $4.5 trillion balance. The Fed will increase this tightening over time but is unlikely to put itself on a preset course. Therefore $10b/month tightening will not intimidate the markets. For as long as this is announced, investors will tick the box and move to the point 2.

Dot-plot

The markets have priced in some balance sheet adjustment but are uncertain when it comes to a rate hike in December and a dot-plot could be decisive here. Only 4 members saw no hike at the meeting in June but subsequent data was somewhat mixed and there’s also some negative impact of hurricanes so expect more members to place their dot at the lower bound. The question is “how many?” If we see 7 to 8 dots for no hike investors could assume that the Board (with J Yellen) is against such move and that could be highly negative for the dollar. Meanwhile if there are up to 6 dots for “no hike” scenario markets could assume that the hike is still on the table and that could support the greenback.

Dot plot could be decisive fot the dollar today, especially when it comes to expectations for December’s meeting. Source: federalreserve.gov 

Macroeconomic forecasts

Forecasts will be adjusted for this year, especially for inflation but do notice that the Fed saw inflation at the target (of 2%) for both 2018 and 2019. Have low readings change its mind? A downward revision of inflation forecasts for 2018/19 could be a negative for the dollar. Growth forecasts can be revised as well but keep in mind that this will have secondary importance – the crucial reaction could come from the dot-plot. 

Inflation forecasts for this year will be slashed but markets will focus on 2018 and 2019. Source: federalreserve.gov 

Meanwhile the EURUSD couldn’t be at more relevant spot. Not only is there a psychological 1.20 but also 1.2050 low from 2012. This could be technically a good point for a reversal but should it be broken there is no limit for a potential rally in sight. 

EURUSD is at the key pivot point ahead of the Fed meeting. Source: xStation5