The market is expecting the FOMC to downgrade the assessment of the U.S. economy. It’s probable they will indicated that employment growth is lackluster, consumer spending has disappointed and housing indicators continue to point to another leg lower. The wording will be less explicit but the market will be spooked by any worrisome signals, however slight. The initial reaction will be a slump in the stock market and that will translate into JPY strength.

 
One possibility is that we will see Bernanke’s “unusually uncertain” phrase included in the FOMC statement. The reaction to “unusually uncertain” would be mostly muted with perhaps some JPY and USD strength.

 
Market chatter also centers around what the Fed will do with money invested in mortgage-backed securities that are expiring. Until recently, it was believed the Fed would destroy the money it used to buy the securities but now there is talk they will recycle the dollars and buy Treasuries or further mortgage-backed securities. With inflation unlikely and deflationary fears rising, we fell this step will eventually be taken. We don’t think a program will be announced today but we expect them to emphasize that there is more they are prepared to do if the economy worsens further. We think such an outcome is USD-neutral. If the Fed, however, talks more explicitly about new programs or introduces them, we will see a broad USD selloff. Currencies like AUD, CAD and EUR would be expected to outperform in such a scenario barring a major downgrade in the economic outlook.

One final thing to watch is Kansas City Fed President Thomas Hoenig. He has dissented at the previous four FOMC meetings and is in favour of raising interest rates. We believe he will continue to dissent. The risk is that he will fall in line with other FOMC members on the “extended period” language. This would be a slight USD-negative. Overall, however, we feel the market (and the FOMC) has marginalized Hoenig.