Stock market preview, September 20

Wednesday will bring investors the week’s big economic highlight.

At 2 p.m. ET, the Federal Reserve will announce its latest monetary policy decision followed by a press conference from Fed Chair Janet Yellen set to begin 30 minutes later.

Expectations are for the Fed to keep its benchmark interest rate pegged inside a range of 1%-1.25% with investors not looking for another move on rates until the Fed’s December meeting.

The change we do expect from the Fed on the policy side is an announcement that the central bank will begin paring down the size of its $4 trillion balance sheet, a more technical adjustment that many expect won’t rattle markets much.

Fed Chair Janet Yellen speaks in Washington, to announce the Federal Open Market Committee decision on interest rates following a two-day meeting in June, 2017. The Fed wraps up a two-day meeting of its policymakers on Wednesday, Sept. 20, 2017. (AP Photo/Susan Walsh)

Also on the schedule on Wednesday will be the August report on existing home sales, due out in the morning.

All three of the major averages hit new records on Tuesday, sending markets into the Fed announcement on a positive note. Recent trading action has been notably subdued, with Bloomberg’s Joe Weisenthal noting Tuesday that S&P futures have moved inside a trading range of just 19 points over the last five trading days.

Charlie Bilello, director of research at Pension Partners, notes that the last five days have been the least volatile in market history, with an average daily trading range of just 0.24% over the last five days.

Meanwhile, the folks at Bespoke Investment Group higlighted Tuesday that since 1994, the S&P 500 has gained, on average, 0.31% on all Fed decision days, including holds, cuts, and rate hikes. The S&P 500, by contrast, has averaged a gain of 0.03% on any given day, so there is definitely more action than normal when the Fed makes an announcement.

Recently, however, this has not held up with the rolling 10-meeting average of S&P 500 moves now coming in at exactly 0%. After the financial crisis, this measure was all the way up to 2%. And so just as markets have seen volatility come down of late, so too has volatility around Fed decisions declined.

Markets have been reacting less and less to announcements from the Federal Reserve. (Source: Bespoke Investment Group)

What the Fed will say Wednesday

The Federal Reserve, the United States’ central bank and the most influential central bank in the world, is an already somewhat inaccessible institution for those not steeped in financial markets to make sense of.

Wednesday will not help this.

On Wednesday, the Fed will announce that it will keep the target range for its benchmark interest rate unchanged between 1%-1.25%. The Fed is also expected to announce that it will begin reducing the size of its balance sheet, which currently stands at $4 trillion.

The red line on this chart will start to come down over time, with this announcement likely on Wednesday. (Source: FRED)

The very short version of how we got here is that after the financial crisis, the Fed began buying assets — Treasury securities and mortgage-backed securities — in an effort to encourage lending in financial markets. It was the seizure of credit markets that really scared bankers and policymakers during the financial crisis, not the decline in stock prices or even the failure of Lehman Brothers.

Now, the Fed wants to have fewer of these assets in its possession. What it will do is not outright sell securities but cease reinvesting the proceeds it receives from a bond that matures into a new security. In time, this will reduce the Fed’s holdings.

Given that the Fed has signaled that it will make this announcement on Wednesday, and undertake this process slowly, expectations are that markets will not be upset by the Fed’s reduced role in markets. This means that interest rates are not likely to be disturbed by this shift and that the rate borrowers get, for example, on their mortgage won’t be impacted. For the average American, then, Wednesday’s Fed moves might go almost unnoticed.

Elsewhere in Fed news on Wednesday, there are currently a number of issues around the central bank that we’d expect Yellen to be asked about. Among them will Yellen’s future at the Fed, which is currently unclear, though a recent poll conducted by CNBC indicated that 38% of participants see President Donald Trump re-appointing Yellen, up from 10% in July; 60% say Trump should re-appoint Yellen.

Brett Ryan, an economist at Deutsche Bank, also noted last week that Wednesday will see the first release of the Fed’s economic projections — including forecasts for GDP growth, inflation, and the unemployment rate — for the year 2020.

Additionally, the resignation of Yellen’s number two at the Fed — vice chair Stanley Fischer — leaves an opening at the Fed’s board of governors and creates the possibility for Trump to re-shape Fed membership, potentially away from those steeped in academia and towards those with a background more focused on the private sector, like the president himself.

Ryan notes, however, that, “Likely left unsaid will be the implications of the nearing end of [Yellen’s] term as Chair, as well as the implications of Stan Fischer’s impending departure.”

Myles Udland is a writer at Yahoo Finance. Follow him on Twitter @MylesUdland

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