The US Fed meets tonight in the marquee markets event of the week, and investors are focused on two things:

– if the Fed will change its forecasts for the pace of future rate hikes; and
– whether the Fed will accelerate the taper of its bond purchase program.

Ahead of the meeting, US stocks fell overnight and bond yields climbed.

So far, the Fed has communicated that central bank liquidity will start to tighten and markets have largely digested those updates.

But some rumblings in the bond market and additional strength in the US dollar “is a reasonably toxic combo for risk”, Pepperstone analyst Chris Weston said yesterday.

Those moves “will have the bears sensing greater volatility into year-end, and will hope the Fed rock the boat this week to get some real-life back into markets”.

In that context, one way to frame tonight’s meeting is whether the Fed does something the market wasn’t expecting.

Framing the Fed meeting

Ahead of the meeting, CBA analyst Carol Kong offered some forecasts on what the Fed might do.

On the topic of interest rates, all eyes will be on the Dot Plot — the bank’s summary of where committee members think rates will go next, which allows markets to ascribe a median forecast for rate hikes.

At its meeting in September, around half the Fed’s committee members forecast there would be at least one rate hike in 2022.

For this meeting, “we expect the median ‘dot plot’ will show the majority of members expect two rates hikes in 2022”, Kong said.

In addition, CBA also reckons the dot plot will point to a higher medium-term interest rate of +2% by the end of 2024 — up from 1.8% last time.

On that front, Kong is even more bullish.

“We consider the FOMC is behind the curve on inflation and will need to raise the Funds rate as high as 2.5%,” Kong said.

If the medium-term dot plot does come out that high, it would be an example of an unexpected Fed forecast that may have implications across asset classes, including stocks and currencies.

On the subject of tapering, economists surveyed by Bloomberg coalesced around the idea that the Fed will pick up the pace there as well — reducing bond purchases by between US$25-US$30bn a month.

“At this pace, the FOMC will finish tapering in March,” Kong said.

However, CBA expects the central bank to cap its monthly taper at US$25bn, which would see the program come to an end in April.

So in aggregate, US$25bn-US$30bn of tapering per month and two interest rate hikes in 2022 are the benchmarks that markets are going into this meeting with.

Any changes to the upside at tonight’s meeting, and it could change some of the liquidity assumptions that have so far underpinned a historic post-COVID rally in global stock markets.