Investors Could Be Lowballing Risk of FOMC Hawkishness, Says Citi

Citi Bank analyst Steven Englander discussed FOMC policy in a research note to clients. Wednesday’s announcement is expected to be the key event next week, with wide implications.

Englander thinks it is probably at least 40% expected that the language will shift from keeping fed funds near zero for a ‘considerable time’ to more data dependent policy guidance. From an FX standpoint, Englander said USD could correct 0.5%-1% if dovish language is retained. On the other hand, he thinks investors could be lowballing risk of FOMC hawkishness.

“Dropping ‘considerable time’ would be a major hawkish step, even if replaced by a ‘data dependent’ pace of rate hikes and a FOMC view that considerable slack remains in place. It would be seen as opening up room for hiking before mid-2015 and as opening risk of a faster move of policy rates to their equilibrium,” said Englander.

“There is speculation that the FOMC may drop the language indicating ‘significant underutilization of labor resources’, but investors will likely see that as secondary. Were they to drop the ‘considerable time’ language, but keep ‘underutilization’ it would still be hawkish from a FX market perspective, because the operational shift would be the dropping of the time commitment. Keeping ‘considerable time’ and dropping ‘underutilization’ would probably be viewed as somewhat dovish, as the concrete assurance of low rates would outweigh the assessment of utilization,” he continued.

"The other uncertainty is whether and how much the dots and economic forecasts move. This is less discussed than the FOMC language, but may be as important," he added. "It is expected that Fed Chair Yellen will strike a dovish tone at the press conference, even if the Statement and forecasts are viewed as more hawkish. We are skeptical that she can walk back concrete hawkishness (such as removal of ‘considerable time’ or shifting dots) with a qualitative press conference comfort message, but this is debated and she is expected to try."

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