(Kitco News) - A two-day Federal Open Market Committee meeting ends Wednesday and economists said they are expecting the Federal Reserve will announce some sort of change on forward guidance as it prepares to end its asset-purchase program.
Economists said the Fed will likely announce another $10 billion reduction in its asset-purchase program to $10 billion in U.S. Treasurys and $5 billion in mortgage-backed securities, following the pace it set at the beginning of the year. The program, known as quantitative easing, is likely to wrap up in October, analysts added.
“As long as the incoming data remain supportive of the Fed‘s outlook, we expect the FOMC to bring the asset purchase program to a close in October,” said Nomura analysts.
The end of QE leaves the Fed needing to define its exit strategy, and economists said the Fed will shift its forward guidance at this meeting. Central banks use forward guidance to influence market expectations of future levels of interest rates, using own their forecasts. Gold market participants will watch to see what the Fed may say on their outlook for interest rates. Last week gold prices fell in part on ideas interest rate hikes may come sooner than originally expected, said Frank Lesh, broker and futures analyst with FuturePath Trading.
“The Treasury market has priced that in. Now we’ll see how bad it’s going to be,” Lesh said.
Paul Ashworth, chief North American economist at Capital Economics, said several Fed official suggested recently it is time to drop the words “considerable time” in reference to how long before the first interest rate hike once QE ends.
“Whether or not the forward-looking guidance will be tweaked at this upcoming meeting is, nevertheless, still up in the air. It is possible that officials can't reach an agreement on the exact wording. With the first rate hike still at least six months away, a decision doesn't need to be taken immediately,” Ashworth said.
Improvements in economic data, such as the rise in the second-quarter gross domestic product, and general improvements in labor markets could mean the Fed may embark on raising the Federal funds rate sometime in the second quarter of 2015, economists said.
“With growth accelerating and labor markets tightening, we expect the FOMC to modify its forward guidance at the September meeting,” Nomura analysts said.
Even though the August nonfarm payrolls came out weaker than expected, Ashworth said the U.S. economy still creates enough jobs for the unemployment rate to fall. “At 6.1% in August, that rate is getting close to the 5.2% to 5.5% range that Fed officials view as the long-run equilibrium,” Ashworth said.
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Kevin Logan, HSBC’s chief U.S. economist, also said he expects the FOMC will unveil a new exit strategy Wednesday. In 2011, the Fed originally said its plan to end highly accommodative monetary policy would be to first reduce the size of its balance sheet and then raise rates. That plan is likely to change, Logan said, because with $4.5 trillion on the books, the balance sheet is too big to make the 2011 plan practical.
“The FOMC will have to decide how it will combine changes in its balance sheet with changes in short-term interest rates in the pursuit of its overall policy goals of maximum employment and stable prices. The FOMC will also have to explain to the public how the evolving framework joining balance sheet changes and interest rate changes will work in practice,” Logan said.
Pointing to the minutes of the July FOMC meeting, Logan said most of the policymakers support retaining a 25-basis-point target range for the Fed funds rate once policy tightening begins.
“However, the primary instrument for policy is likely to be the interest paid on excess reserves, or IOER. The interest rate offered on the Fed’s overnight reverse repurchase facility, (or) ON RRP, is likely to play a supporting role. The IOER should set the top of the target range for Fed funds while the ON RRP rate sets the bottom of the range,” he said.
Ashworth said Fed Chair Janet Yellen is scheduled to speak after the meeting, and she may use the time to explain any changes. “In particular, Yellen could take the opportunity to stress that any change in language doesn't necessarily mean that the first rate hike is likely to come sooner than previously expected,” he said.
Lesh said “the fear trade” for gold has been priced in, meaning that much of last week’s weakness was positioning ahead of confirmation of a less accommodative Fed. Given that Commodity Futures Trading Commission data shows the gold market shows a hefty number of established short speculative traders, gold could see a short-covering reaction after the news comes out.
If the news comes out as expected, there could be some shorts covering to take profits, he said. Or, if the news is less hawkish than expected, shorts may be forced to cover. A rally could take gold up to technical chart resistance which runs from $1,263 to $1,275, but then “the rally could run out of steam,” Lesh said.
If the Fed is perceived to be more hawkish, or if traders decided to sell gold, the market could target psychological support at $1,200, with the year’s low of $1,185, basis the December gold contract, key support.
“We could see some further weakness, but it won’t be at the rate we saw last week,” he said.
By Debbie Carlson of Kitco News; dcarlson@kitco.com
Follow me on Twitter @dcarlsonkitco
