FOMC Meeting in Focus this Week

The S&P 500 closed above 2500 for the first time as the longer term uptrend continues. The gains came despite the fact that retail sales data released on Friday was significantly worse than expected. Core retail sales were up 0.2% for the month when the forecast was for a 0.5% increase. The prior month gain was also revised down by 0.1%. Furthermore, industrial production for the month of August declined by 0.9% when a gain of 0.1% was expected. The positive close in the major US indices could be related to a market expectation that poor economic data will make the Federal Reserve (Fed) less likely to continue hiking rates.

The pound (GBPUSD) had a very strong week last week as rate hike expectations come into focus. Inflation in the UK is within the target band and the Bank of England hinted that rates could rise sooner than expected. The pound has gained approximately 5% against the US dollar since the beginning of September.

This week, the Federal Open Market Committee (FOMC) has its six-weekly meeting where it makes its interest rate decision. Virtually no-one expects it to raise rates at the meeting however it is widely expected that it will announce the beginning of its balance sheet normalisation process. The Quantitative Easing (QE) programs implemented by the Fed over the past several years have led to an accumulation of treasury and mortgage bonds on the Fed's balance sheet. So far, the Fed has been reinvesting the proceeds of any maturing bonds so that the total value of bonds has been maintained at approximately $4tn. At some point, the Fed will need to start reducing the number of bonds it holds to withdraw the liquidity that it pumped in as part of the QE process. At this week's FOMC meeting it is expected that it will announce that it intends to stop reinvesting maturing bonds and therefore let the total balance start reducing. The practical implications of such a process are that bond yields could start to rise which would ultimately start putting upward pressure on other interest rates within the economy (such as mortgage rates).

  

Data Release:

–    Euro Final CPI 7:00pm AEST

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This article was written by William O'Loughlin – Investment Analyst, Rivkin Securities Pty Ltd. Enquiries can be made via [email protected] or by phoning +612 8302 3633.