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Ben Bernanke and his colleagues in the FOMC are meeting to decide on monetary policy and QE tapering is on the agenda. Will the Fed reduce the number of bond buys? If so, how much? Will it be accompanied by some kind of sweetener? And if tapering isn’t announced, will the Fed make it clear that tapering is due in the next meeting?

Here are the possible scenarios for the decision and the expected market reactions.

The FOMC statement and the accompanying FOMC economic projections are released on Wednesday, December 18th, at 19:00 GMT. Ben Bernanke begins his press conference at 19:30 GMT.

News out:  Fed announces $10 billion QE tapering with softer forward guidance – USD jumps but hesitates

Live blog:  Bernanke explains the sweet taper

Analysis:  Sweet Dectaper is still a taper – USD has the upper hand

Expectations

There are good chances that QE tapering will be announced. Here are 11 reasons for QE tapering. The improvement in the job market, steady inflation, a better political climate and the separation between tapering and rate hike expectations are among the reasons supporting a move now.

There is no clear consensus about the Fed’s move. For example,  Simon Smith estimates a 40% chance for a “Dectaper”. So, no “buy the rumor, sell the fact” move is likely. Basically, an announcement of QE tapering is likely to boost the US dollar, while another “no taper” is expected to weaken it.

The reaction is also dependent on some details.

Scenarios

  1. Simple QE tapering: The Fed announces a reduction of bond buys of around $15 billion without committing to the next moves and without offering any sweeteners. Given all the reasons to taper and the Fed’s approach that every move is data dependent, this option has a high probability. In this scenario, the dollar is due to gain nicely.
  2. No QE tapering but a thick hint for January: In this scenario the Fed hints it is closer to tapering than seen in September, and that QE tapering is imminent. A thick hint, together with no dissent from Esther George, the most hawkish voting member on the FOMC, could push the dollar slightly higher. Probability: medium-high.
  3. No change in policy: The Fed might opt to leave policy unchanged without supplying any hint. A need for more evidence is what the Fed did in September. In this case, which has a medium probability, the dollar is set to plunge. Expectations will return to March-April, when Yellen is in charge.
  4. QE tapering with a sweetener: In this scenario, the Fed announces tapering but also offers some kind of monetary easing move to balance it. A reduction of the  interest paid on reserves (IOER) is an option. Another option for a sweetener is a change in the thresholds for lower rates. Some expect that the Fed will lower the unemployment rate threshold from 6.5% to 6% in order to adapt to the falling participation rate. However, as the drop in the participation rate is due to retirement according to the Fed’s own paper, a new threshold is a more remote option. Any kind of sweetener could curb the dollar’s gains. Probability: medium.
  5. QE tapering with a  road map  to end QE: The Fed talked about potentially  ending QE in mid 2014. If the Fed mentions a potential date to stop bond buying altogether, even if this is after June 2014, this will send the dollar rallying. An end date to QE would be a very hawkish move. The probability is low, as the Fed prefers to send a message that the policy is accommodative.

All in all, markets are expected to move quite a bit. Previous Fed decisions resulted in big movements not only in the immediate aftermath, but also in the consequent Asian and European sessions, as well as having a long term impact on currencies.

What do you think? What will the Fed do?

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