Tonight sees the culmination of the latest US Federal Reserve’s latest Federal Open Monetary Committee (FOMC) meeting and, despite markets widely expecting an interest rate hike when the policy update is announced at 7pm, it is still uncertain as to what the effect on markets may be.

In order to assess what impact the meeting will have on markets, investor focus will turn to what has, or perhaps hasn’t, been said, as well as the updated 2017 outlook. The two-day meeting of policymakers concludes this evening, with a policy statement released at 7pm shortly followed by a press conference from Chair Janet Yellen half an hour later.

Interest rates & outlook

The meeting is widely expected to result in the second US rate hike of 2017, as the Fed reacts to a tightening labour market (Unemployment has fallen to the lowest in a decade) and continued optimism of a re-energised US economy. Fed fund futures, a popular gauge of expectations for rate hikes, currently show a 95% probability that the Fed will hike today. Furthermore, today’s meeting fits the pattern of all rate hikes since December 2015 – the meeting is followed by a press conference.

At the FOMC’s December 2016 meeting, policymakers generally held the view that they would undertake four rate hikes over the course of 2017. In March, the committee agreed 8-1 to raise interest rates, although the accompanying statement proved to be less hawkish than expected.

With US macroeconomic data beginning to wane, most recently with soft Non-Farm Payrolls and Average Weekly Earnings prints, investors will now focus on whether suggestions of two further rate hikes are reiterated.

If not, likely resultant US dollar weakness will have a detrimental effect on major European and US indices, as well as aiding bullish sentiment for safe haven assets such as precious metals and the Japanese Yen.

Addressing the balance sheet

Moving away from interest rates, many investors are hoping for some mention of the trimming of the Fed’s balance sheet having been bloated by the continued effect of the central bank’s post-crisis quantitative easing that began in 2008-9.

The balance sheet, the total value of assets currently owned by the Fed, has swelled to $4.2 trillion since the 2008 financial crisis, as proceeds from the QE program are reinvested upon reaching maturity. Trimming the balance sheet would remove the floor for bond markets in the US having acted as an artificial buyer for 9 years, and would therefore be seen as a hawkish move by the central bank; having been in place for almost a decade, the move would instill confidence that the US economy has recovered and is stronger now than at any other point after the financial crisis. This process of policy normalisation is looking to be echoed by the European Central Bank.

While policymakers have so far shied away from the issue, should the balance sheet be addressed or, at the very least, discussed at the meeting, it will mark yet another move by the Fed that stresses confidence in the economy. The total process will likely take years or even decades to complete, but taking the first steps towards it would likely be welcomed by investors. Expect the US dollar to rally, while safe-haven Gold falters, if this is that case.

Remember, the rate hike itself is not expected to be a driver for markets, outlook will be key; the path for policy over the remainder of 2017 and beyond will be the real issue in question.

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Henry Croft, Research Analyst, 14 June