Trading the Fed's June Meeting
Tuesday, risk assets continued a strong rally off of early July lows ahead of Wednesday's FOMC statement and press conference from Fed Chairman Ben Bernanke. The major U.S. equity averages traded at multi-week highs and the markets appeared to be pricing in dovish commentary from the Federal Reserve. In afternoon trading, the Dow was up more than 120 points, or 1.02%.
Among the top performing sectors on the day were financials, basic materials, and energy as traders looked to take on more risk. Defensive sectors such as consumer staples and utilities were underperforming the broader equity market. Speculation built in the market that the Fed might extend its "Operation Twist" program beyond its scheduled end in June. The program was designed to bring down long-term interest rates and flatten the yield curve. Under the program, the Fed has been selling short-dated Treasuries and buying longer-dated maturities.
Treasury yields traded near record lows during the days preceding Tuesday. This may have occurred as a result of Federal Reserve purchases and zero interest rate policy (ZIRP), along with significant market fears over the European sovereign debt crisis. On Tuesday, yields rose, however, as investors prepared for the following day's market moving events. Yields on the 10-Year Note rose around 4 basis points to 1.62%. The Barclays 20+ Year Treasury Bond ETF (NYSE: TLT) lost 1.3% to $125.42.
TLT hit an all-time high in early June, while stocks were hitting new 2012 lows. The bond markets may be very active in the wake of the June 20 FOMC statement. Short-term traders might find volatility in Treasury futures and related ETFs such as the TLT and the ProShares UltraShort 20+ Year Treasury ETF (NYSE: TBT), which rises along with interest rates. The gold market has also been very volatile during days of previous Fed statements. This is another area that traders might want to watch on June 20.
A strong rally may be likely if the Fed provides more dovish commentary relating to monetary policy. On Tuesday, gold lost around 0.5%. Gold had been grinding higher since around mid-May and could make a run towards $1,700 if the Fed indicates it is going to extend Operation Twist or even implement QE3. Some investors have speculated that the Fed may also extend its language about "exceptionally low" interest rates to "into 2015" from the current "late 2014" language.
While many market participants believed that the Fed would provide some kind of monetary policy support to the markets on June 20, the Fed statement might still come up short of expectations. Given that risk assets surged Monday and Tuesday on heightened expectations, investors could be considerably disappointed if these expectations are not met. This disappointment might commence a large sell-off in stocks and commodities. The selloff might be particularly intense if the Fed provides bearish commentary on the economy, without providing any additional support.
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