Up Ahead: Expect Careful Wording from the Fed
09/15/2014  |  David Joy

Although Labor Day was early this year, and a full complement of investors has been back at work for two weeks now, the week ahead is where we truly get down to business.

The big event of the week is the Fed meeting on Tuesday and Wednesday. Since there was no meeting in August, it has been some time since we last heard from the Federal Open Markets Committee (FOMC) and Fed Chair Janet Yellen directly.

This week's meeting will be accompanied by a press conference. It also will include new economic projections. And although the August jobs report was a little soft, we are presumably just a few short weeks away from the wind down of the current round of quantitative easing, QE3.

What the Fed is currently thinking about the future path of monetary policy, and how it intends to communicate that thinking, will dictate the near-term market response. Already, bond yields have begun to adjust to the expectation of less stimulative policy going forward. The yield on the ten-year Treasury note has risen almost 30 basis points in just the past two weeks, from 2.32 to 2.61 percent.

This is an abrupt turnaround, after its yield had declined steadily from the beginning of the year when it stood at 3.00 percent. The recent increase in the two-year note yield has been decidedly more modest, just five basis points over those same to weeks, to 0.55 percent. But, the adjustment in the two-year yield has been underway for much longer, edging higher since February when it stood at 0.29 percent. The challenge for the Fed is whether to adjust the language of its meeting statement, and if so, how to do it in a way that does not unnerve investors.

The punch bowl is eventually being taken away. That is understood. But how abruptly is the question. Expect the Fed to reiterate that its future actions are data dependent, and that it intends to remain considerably accommodative.

But with QE3 going away soon, the clock will begin ticking on the first rate hike, and until just recently investors were seen as underestimating how quickly the Fed might raise rates once they do begin, generally expected to be sometime around next June. The San Francisco Fed pointed this out last week. But that adjustment now appears to be underway.

Even stock prices have recently plateaued. After establishing a new record high after the September 5 release of the August jobs report, the S&P 500 drifted lower last week in the face of rising bond yields, among a host of other worries. The index dropped 1.1 percent, falling for the first time since the week ending August 8.

The Rallying U.S. Dollar

Another notable reaction to the evolving monetary picture has been a robust rally in the dollar. Since the end of June, the DXY dollar index has climbed 5.6 percent. During that time the euro has fallen from 1.37 to 1.29 versus the dollar. The dollar has climbed from 101 to 107 versus the Japanese yen. These moves are reflective of the differing outlooks for economic growth and monetary policy, as the Bank of Japan and European Central Bank are expected to increase their degree of stimulus as the Fed is preparing to move in the opposite direction.

Commodity prices, which are traded in dollars, have been pressured as a result. The S&P Goldman Sachs Commodity Index is down 11 percent since the end of June. Not helping, of course, has been softer economic data from China. But for U.S. consumers, the strong dollar helps to keep a lid on prices. Particularly beneficial has been the recent decline in oil prices exerting downward pressure on gasoline prices. According to AAA, the national average for a gallon of regular unleaded is now $3.39, down from $3.47 a month ago and $3.52 a year ago. And lower prices will marginally take some pressure off the Fed, as inflation continues to run below its long range target of 2.0 percent.

Geopolitical concerns remain firmly on the radar screen this week as well, as a U.S.-led response to the Islamic State in Iraq and Syria (ISIS) threat develops, while the ceasefire in Ukraine appears tentative, and Scotland goes to the polls to determine its future in, or out, of the U.K. And the U.S. economic calendar includes the latest readings on industrial production, inflation and housing activity.

So, there is a lot to think about in the week ahead. But unless the unexpected happens, the Fed meeting and its outcome will overshadow everything else.

Important Disclosures:
The views expressed are as of the date given, may change as market or other conditions change, and may differ from views expressed by other Ameriprise Financial associates or affiliates. Actual investments or investment decisions made by Ameriprise Financial and its affiliates, whether for its own account or on behalf of clients, will not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not account for individual investor circumstances. Investment decisions should always be made based on an investor's specific financial needs, objectives, goals, time horizon, and risk tolerance.

The Standard & Poor's (S&P) 500 Index tracks the performance of 500 widely held, large-capitalization U.S. stocks.

The U.S. Dollar Index (DXY) measures the dollar's value against a trade-weighted basket of six major currencies.

The S&P Goldman Sachs Commodity Index is a composite of diversified, unleveraged commodity futures which serves as a commodities market benchmark and an economic indicator.

Investment products are not federally or FDIC-insured, are not deposits or obligations of, or guaranteed by any financial institution and involve investment risks including possible loss of principal and fluctuation in value.

Ameriprise Financial Services, Inc. Member FINRA and SIPC.

© 2014 Ameriprise Financial, Inc. All rights reserved.

distributed by