FOMC Tapering Isn't Tightening

Includes: UDN, UUP
by: FXstreet

While investors seem to have priced in a dovish FOMC policy, we should bear in mind that markets might act quite differently if FOMC does not fully deliver on these expectations.

Traders have already priced in a modest tapering, but what if FOMC does not fully deliver on these expectations? Yesterday, traders were especially muted on US CPI and TIC results, mainly due to the fact that they have already priced in a modest FOMC outcome, i.e. a modest taper of $10-$15 billion in combination with some additional forward guidance rhetoric. But we should take a more thorough look to see behind the curtains in order not to be taken aback if the FOMC fails to deliver on the vast majority of investor world expectations.

First of all, we should note that the Fed decision is currently characterized by the "sooner" than "later" tapering rhetoric of late, as well as on the decision about how much to taper. There are many moving parts and even the dovish or hawkish outcome does not seem to be dependent only on the above factors. Elaborating further, we should not only focus on the amount of tapering but on how the Fed will proceed in the long term. Ben Bernanke has already stated that mid 2014 is the deadline to end QE.

Keeping in mind that, the first thing traders should consider isn't the initial amount of money to taper, but what can one "read between the lines" in terms of the future "tapering" and to the timeline. While traders have been stuck thinking that a dovish FOMC would by any means be characterized by a very light amount of money to start "tapering" in combination with some additional forward guidance, things do not seem to be that easy. The FOMC would indeed release a modest tapering of $5B-$10B, but if that is accompanied by a very aggressive taper in the months ahead and/or in tight accordance with the middle of the 2014 timeline, then that would be a "hawkish" result by any means, thus extremely good news for the greenback.

On the other side, FOMC could deliver a result of a higher amount of tapering, e.g. $15B-$20B, but then decides to move on very slowly and extend tapering beyond 2014. That would also catch traders off guard. In that case the "reading between the line" message would be a very dovish FOMC. All in all, investors should focus not only in the initial amount of tapering or if it starts now or a bit later this year in November or December. They should rather pay attention to the forward guidance that will accompany the minutes, any changes in forecasts, the future path of "tapering" and the willingness to stick or not with the "timeline."

Last but not least, Yellen is now the overwhelming favorite for the job of the most influential Central Bank in the world. That's good news for traders, as if she gets elected the credibility on FOMC projections and forward guidance will be heavily boosted as she is considered to be the leading force behind the current Fed's communication policy.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.