On Wednesday, the Fed will communicate its decision on interest rates and overall monetary policy. While the consensus is that the Fed will not change anything in its policy mix, the focus shifts on the forward guidance offered by Fed’s Powell during the press conference. 

One may wonder what the new confirmed cases of COVID-19 in Israel have to do with the Fed’s policy? I would say – a lot!

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Brighter Outlook for the U.S. Economy

Israel is the world’s leader in the vaccination race against the COVID-19 virus. It managed to inoculate over 40% of its population, and the entire world watches the effects closely. As a comparison, the United Kingdom sits at 10% and the United States at 6%, while the European Union average is 2%.

So far, the world has not seen if and how the vaccines work. Effectively, there was not a large-enough sample – but now it is. The chart above clearly shows the positive effects of vaccination, and for traders, this means the economies will reopen faster than predicted at the start of the pandemic.

If we see such results in Israel, the implications are that we will see something along the same lines in other countries, too, by the time the vaccination reaches such levels. Therefore, the risk at the Fed’s meeting on Wednesday is that it might hint at the tapering of the quantitative easing program and thus offer hawkish forward guidance.

The current monetary policy stance in the United States has the federal funds rate at the lower boundary of 0%-0.25%. This is as low as the Fed will go. Moreover, the Quantitative Easing program runs at a pace of $120 billion ($80 bln Treasuries and $40 bln MBS – Mortgage-Backed Securities).

The risk at the event is that the Fed might hit that a brighter outlook does not warrant keeping the easy stance for long. Because financial markets, especially the currency markets, move way ahead of the central bank, the risk is that the dollar will take a nasty turn.

Also, the U.S. growth projections for the year show an economy that might grow by over 5% in 2021. If inflation expectations remain that elevated as they are now, we should not be surprised if the Fed will have an optimistic tone.

After the ECB last week delivered a hawkish message, is it time for the Fed to do the same?