Markets Primed for Dovish FOMC Outcome May Be Disappointed

German Unemployment and CPI figures headline the economic calendar in European hours. The former data set is expected to show no change in headline labor market indicators in October, with the ranks of the jobless holding steady from the prior month while the unemployment rate remains at 6.9 percent. The latter report is forecast to see the baseline year-on-year inflation rate holding at 1.4 percent, matching September’s result.

On balance, such outcomes offer no meaningful impetus for markets to re-appraise status-quo ECB policy expectations, and as such seem unlikely to yield much of a reaction from the Euro. Overall Eurozone economic news-flow has deteriorated relative to expectations over the past two months according to data compiled by Citigroup. While this opens the door for downside surprises, the probability of an outsized reaction from the single currency (much less of seeing lasting follow-through) seems rather low before the markets can put today’s FOMC policy announcement behind them.

Needless to say, investors are looking to the Fed meeting to offer guidance on when officials will begin to “taper” the size of the QE3 stimulus program. Fiscal drag considerations following October’s US government shutdown have pushed back expectations on when the policy normalization process will commence, with the baseline view now looking for the first cutback in March 2014.

The incorporation of this view into asset prices weighed on the US Dollar over recent weeks, dulling the impact of any overtly dovish rhetoric that may emerge in the FOMC policy statement. That means that any large-scale volatility that occurs after the results of the Fed sit-down cross the wires is likely to come from an indication that the unwinding of QE may be closer on the horizon than current expectations are accounting for. In this context, broadly unchanged Fed commentary may be seen as comparatively hawkish considering investors seem primed for a noticeable lurch toward the accommodative side of the spectrum.

The absence of a discernible dovish tone shift may thus weigh on risky assets and boost the greenback. Such a scenario seems reasonable. Recalling the ultimately unfounded fears of the fiscal drag from the payroll tax hike and “sequester” spending cuts on the US recovery earlier this year, the chance that worries about the shutdown’s impact are overstated is a real one. Furthermore, the Fed’s recently spotty record of managing expectations means officials will probably want to see more hard evidence before tinkering with existing guidance.

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