GDP Annualized (4Q A) (13:30 GMT; 08:30 EST)
Expected: 1.2%
Previous: 4.9%

FOMC Rate Decision (19:15 GMT; 14:15 EST)
Expected: -50bp to 3.00%
Previous: -75bp to 3.50%

What Are The Markets Facing?

The gloomy US economic picture may only get worse on Wednesday morning, just ahead of the Federal Reserve’s highly anticipated rate decision, as Q4 GDP is expected to reflect a slowdown from Q2 to 1.2 percent. However, there is speculation that the figure could be much worse, as fears of a looming recession remain a hot topic in the news. Nevertheless, market reaction may be limited as the marquee event is the FOMC rate decision at 14:15 EST. Currently, Fed fund futures are pricing in an 82 percent chance of a 50bp cut to 3.00 percent and, but if you ask the traders in the DailyFX Fed Cut Forum, there is a chance that the central bank is leaning towards a 25bp cut or no cut at all. How the forex, fixed income, and equity markets will react to the news will be dependent primarily upon the actual policy decision, but the accompanying statement could make an impact as well. If the Fed cuts rates, but suggests that inflation pressures are becoming worrisome, the markets may start to bet that they will leave rates steady at their next meeting in March. On the other hand, a continued focus on the “appreciable downside risks to growth,” “deepening of the housing contraction,” and “softening in labor markets,” Fed fund futures may price in further rate reductions, which will have implications throughout the financial markets. Given all of the dovish potential surrounding the upcoming FOMC meeting, there may be more gains in store for Treasuries and US equities, while additional weakness may await the US dollar on Wednesday.

Bonds – 10-Year Treasury Note Futures

The Fed’s emergency 75bp rate cut added fuel to the Treasury rally, but with the contract looking overbought it appears that a blow-off top may be in place. While a Fed rate cut could push US bonds higher, Treasuries may instead fall towards support at 115-15 and 114-32, especially if equity markets continue to recover. On the other hand, if traders become more aggressive in pricing in another round of rate cuts in March, Treasuries may rally again towards the recent high of 119-05.

FX – EUR/USD

The Federal Reserve’s emergency rate cut helped propel EUR/USD up towards 1.4900, though immediate resistance sits above at 1.4800. However, with fed fund futures pricing in another round of rate cuts on Wednesday and the European Central Bank maintaining a staunchly hawkish tone, it may only be a matter of time before the pair takes its rally towards the record highs and the psychologically important 1.50 level. Furthermore, markets will likely remain extremely volatile and create choppy price action across the majors, but Wednesday’s US economic data could weigh on the greenback as 50bp or 75bp rate cut would hammer the currency lower. Indeed, lower US overnight lending rates along with the ECB’s hawkish stance could send EUR/USD rocketing through resistance towards the record highs once again.

However, with price pressures building vis-à-vis food and energy, there is speculation that a rate cut will only stoke inflation further. Moreover, Federal Reserve Governor William Poole did not vote for last week’s emergency rate cut, suggesting that everyone may not be on board to aggressively reduce rates. In the case the central bank leaves rates steady, or only cuts rates by 25bp and issues a policy statement that indicates they will remain neutral in March, EUR/USD will likely pull back sharply towards 1.45.

Equities – Dow Jones Industrial Average

Has the Federal Reserve staved off a stock market crash? One may believe so by looking at the Dow’s bounce from Tuesday’s lows, as the 12,000 level served as a springboard for the index and market sentiment turned more optimistic. However, heavy resistance at 12,500 has thus far prevented additional rallies for the Dow. Nevertheless, gains could continue in the near-term to target 12,825 as the FOMC is widely anticipated to cut rates by 50bp to 3.00 percent. Equity traders in particular are counting on a rate cut and will continue to rally until the Fed says “stop” and leaves rates unchanged. As a result, a rate cut in line with expectations will likely give the Dow at least a slight boost to push through 12,500, and if the policy statement is overtly dovish or if the FOMC surprises the markets with a 75bp cut, US equities may rally fiercely.

On the other hand, if the FOMC holds their ground and leaves rate unchanged, US equities will sell off significantly to target the 12,000, though given how bearish this decision would be, this support level may not hold for long as the Dow would move towards the January 22 low of 11,635.

Terri Belkas is a Currency Strategist at FXCM.