On Deck This Week: Fed Policy - Analyst Blog

On Deck This Week: Fed Policy

 

This week, a major Federal Reserve policy meeting is happening Tuesday and Wednesday. Traders may be keeping to the sidelines until they see what happens to interest rate policy. Indeed, stock markets were trading quietly on Monday.  

 

In addition, two major players will be introduced to the Fed meeting circuit.  There is the introduction of a new Fed Vice Chairman, Stanley Fischer, and a new Fed voting board member, Lael Brainerd to evaluate.  Both M.I.T. economists bring a deep background in the international arenas.  That could alter the support and opinions U.S. Fed chair Janet Yellen hears on a daily basis.

 

Three following fixed rate discussions could be in play.

 

(1) The taper decision of knocking down $10 billion in U.S. treasury and mortgage bond buying each month.  Traders want to know.  Is it still on?

 

(2) The U.S. short rate move pegged to the middle of 2015. Traders want to know. Is this still solid? Bank of England leader, Mark Carney, made public statements recently that the U.K. policy rate will be raised sooner than markets expected.  This leaves U.S. traders with more doubt on U.S. moves. What could the U.S. Fed head Janet Yellen do at this meeting?

 

(3) Finally, the real issue. The first two policy setting points are the obvious rate policies to think about. What is also going on in trader's minds is the behavior of the long-term interest rates. Long-term interest rates are seen as the sum of short-term interest rates.  The final, and biggest, idea in play is this.  If the short rate starts going up in the middle of 2015 --how much higher, and how fast-- will subsequent short rates continue to rise? 

 

If short rates go up rapidly once they start rising, long-term interest rates can shoot up from their place between a range from 2.5% to 3.0% to close to 4% --all in a few weeks. That is enough to shock fixed income markets and change the dynamics of global asset allocation dramatically.