Nov. 2011 FOMC Meeting

Summary Outlook: On Wednesday, November 2 at 1230EDT/1630GMT, the FOMC is expected to announce a mostly steady policy decision, but the focus will be on whether the Fed engages in a third-round of asset purchases or QE3. Bernanke will hold his quarterly press briefing later at 1415EDT/1815GMT, where he will also present the latest revisions to Fed GDP and CPI forecasts. In recent weeks, three voting members of the FOMC have indicated a preference for QE3 to be used to purchase mortgage-backed securities (MBS) to support the US housing market and to strengthen the tepid recovery. By directly targeting mortgage rates rather than long-term US government debt, the Fed could push retail mortgage lending rates lower, enabling more households to refinance and pumping some additional cash into consumers’ hands. QE3 directed at MBS would complement the White House’s effort to increase the availability of the HARP program, though final details won’t be known until around Nov. 15.

We think it’s a very close call on whether the Fed embarks on QE3 at this meeting, but our preference would be for QE3 at the Dec. 13 meeting, after the HARP revisions are clarified. Still, if the Fed goes for QE3 at Wednesday’s meeting, we would expect to see the USD come under pressure and for risk assets to rebound. The size of QE3 will matter, and current market estimates are that it will be around USD 500 bio, though an amount of USD 1 trillion or greater would be more convincing and trigger a larger market response. Risk may find some support even on the mention that QE3 was discussed, which could come in Bernanke’s Q&A with reporters.

Market Strategy: FX and other major asset markets are continuing to heave about based on the latest Eurozone debt developments, but risk sentiment has definitely deteriorated sharply in the last 48 hours. We think the idea of a Greek referendum will eventually be withdrawn under pressure from EU and G-20 leaders, and this could see risk sentiment rebound in the short-run (next 48 hours). QE3 from the Fed could also deliver an additional source of market optimism if it materializes tomorrow afternoon. Our overall preference, however, is to use bounces in risk markets to establish short-risk positions on the belief that the EU debt crisis will not be resolved until the ECB commits to using its balance sheet to limit contagion to the likes of Italy and Spain. To date, the ECB has indicated it will not step up as the lender of last resort, nor undertake unlimited buying of troubled EU sovereign debt. We think Thursday’s ECB meeting will see that message reinforced by the newly installed ECB president, Mario Draghi. If the ECB excludes itself from additional unconventional measures, we would expect risk appetite to go back to ‘off’ mode by Thursday and into the end of the week. In particular, we would use EUR/USD 1.3950/4000 and AUD/USD 1.0450/500 as areas to get short, keeping stops relatively tight at 50-70 pips due to current volatility.

Source: Forex.com

01.11.2011