Markets are nervous heading into the December FOMC meeting and a potential U.S. government shutdown. Volatility is up (“VIX”), and on Monday, U.S. equity markets finished in the red, writes Amelia Bourdeau Tuesday. She's presenting at MoneyShow Orlando Feb. 8.
It didn’t help that President Trump stirred the pot, tweeting his discontent at the Fed.
All of the ongoing event risk is keeping safe-haven assets bid into year-end.
A dovish hike?
The FOMC releases its policy announcement on Wednesday, December 19 and is expected to deliver a 25bp rate hike, bringing the Fed Funds target range to 2.25% - 2.50%. This result is priced into the market.
Traders are hoping for a “dovish” hike. What does this mean? Traders want the Fed to deliver something for everyone -- the 25bp rate hike that is priced in, a downgrade to the median 2019 rate hike forecast or “dot plot,” and more dovish tone to the FOMC statement.
It is hard to please everyone, however. Markets seem to realize this as well – volatility, measured by the VIX Index (“VIX”) has risen, moving up nearly 3 points to 24.5 on Monday. President Trump added to market discomfort that day by heckling the Fed via Twitter.
Trump Twitter comments on the Fed, in a timeline compilewd by Bloomberg.
Wait – there’s more
Thirty minutes after the FOMC statement release, Fed Chairman Powell will hold a press conference. He will have to carefully navigate questions regarding the Fed’s forward guidance and his shift toward a dovish stance on November 28 when he suggested in a speech that the Fed’s policy rate was “just below” neutral.
This comment buoyed U.S. equity markets as traders took it as a sign that there would be fewer rate hikes ahead.
Fed Powell’s dovish comments in November here, from Reuters.
With traders expecting dovish language from the Fed on Wednesday, the risk is that the FOMC statement or Powell’s comments at the press conference are less dovish than the market would like.
That scenario would negatively impact U.S. equity indexes and cause volatility to rise further.
Winter is coming. Safe-haven bid remains
The December FOMC is not the only risk for markets, however. Also on the radar screen are: a possible U.S. government shut-down in the next week, continued Brexit drama, ongoing trade tensions between the U.S. and China, and Italy’s budget dilemma.
As a result, safe-haven assets are in demand. Despite lower U.S. yields lower, the U.S. dollar (USD) has remained strong (chart).
Chart: USD Index (DXY) vs. U.S. 10-year yield (Source: Bloomberg)
As the S&P CBOE Volatility Index (VIX) has risen, so has the price of gold (XAU) – (chart).
Chart: VIX Index vs. Gold USD Spot Price (Source: Bloomberg)
Lastly, stronger Japanese yen vs. USD (USD/JPY) remains correlated with the Dow Jones Industrial Average (DJIA) on its heavy down days (chart).
Chart: USD/JPY vs. DJIA Intraday (Source: Bloomberg)
Note: USD/JPY lower as DJIA falls
Eyes on the prize
Given the U.S.-based event risk through year-end – Fed announcement /press conference and possible US government shutdown -- JPY and gold (XAU) will likely be the main beneficiaries.
The effect of the Fed being less dovish than market expectations on the USD is a bit complicated. If that scenario occurs, the USD reaction could depend on how “less dovish” the Fed is. If the Fed is “less dovish” by a significant margin, the USD could strengthen as U.S. yields may rise.
What to do? As noted above, the intraday correlation between USD/JPY and DJIA is clear when U.S. equities have heavy down days. So, I am going to take my cue from the equity market. If U.S. equity markets fall over these two events – Fed announcement/press conference and possible federal government shutdown – then JPY and gold will be my safe-haven assets of choice.
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Watch Amelia Bourdeau in a short video: Never waste a crisis when trading.
Recorded: TradersExpo Las Vegas, Nov. 13, 2018.
Duration: 2:58.
Amelia Bourdeau: Trading volatility, in a short video.
Recorded: TradersExpo Las Vegas, Nov. 13, 2018.
Duration: 4:31.
