The Federal Reserve is set to convene next week, with Wall Street and the global financial community eagerly awaiting their decision on interest rates. The Federal Open Market Committee (FOMC) is scheduled to announce its rate decision on Tuesday, September 20th, 2023. The consensus among traders is that the Federal Reserve will maintain the status quo in September, with only a small minority of 3% predicting a rate hike this month.
However, expectations for the November meeting suggest a shift in sentiment, as 30% of traders have factored in a potential increase in rates. This change in outlook is largely due to positive economic data indicating a robust economy, reducing the need for future rate cuts. As a result, risk markets and stocks have benefitted from this favorable economic climate.
The long-term trajectory of the Federal Reserve's benchmark rate, the Fed funds rate, through September 2027 is also under scrutiny. Despite a minor uptick in near-term expectations, there's a prevailing belief that the Fed might not be done with rate adjustments. An additional increase of 25 to 50 basis points is considered possible before a downward turn begins, indicating anticipated rate cuts starting in 2024.
The Citi economic surprise index, which tracks data surprises relative to market expectations dating back to 2003, shows elevated levels compared to historical data. The current economic climate is seen as a 'Goldilocks' situation – not too hot or too cold – leading traders to believe that the Fed doesn't need to intervene too much under these conditions. They also do not foresee a recession anytime soon.
However, should an unexpected recession or negative event occur, traders anticipate a significant repricing of risk. In this context, bank reserves and their correlation with the S&P 500 are being closely monitored. Despite the S&P 500 climbing significantly over recent quarters, bank reserves have remained relatively flat, raising questions about whether this gap will close.
The Federal Reserve's total balance sheet is nearing $8 trillion, down from approximately $9.5 trillion. This decrease is seen as a substantial drag on the economy. The Fed's stance on quantitative tightening and its impact on the economy are expected to be key topics of discussion during the upcoming meeting.
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