Markets in quiet mode ahead of the Fed decision/press conference following a volatile Tuesday in the news. GBP traders await the 3rd ballot for PM contenders about 1 hour before the Fed announcement. US President Trump reached out with a phone call to Chinese President Xi on Tuesday and both sides agreed to meet at the G20 and restart trade talks. The announcement spurred already rallying indices after Draghi's easing hint. UK May CPI slipped to 2.0% from 2.1%. Both DOW30 and FTSE100 trades were stopped out. A new trade ahead of the FOMC decision will be released this afternoon.

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Trump revealed the change in tone via a tweet saying they will have extended talks at the G20. Staff level talks will also restart ahead of the meeting. At the same time, the reaction in Chinese media to the talks was tepid. They highlighted that it was the US that reached out and said the chances of a deal were slim. That's a hint that China hasn't wavered in its red lines.

USD/JPY immediately jumped 45 pips on the headline and the news added to an already-big day for stock markets. Gains earlier had been spurred by Mario Draghi, who said the ECB would act “in the absence of improvement” in economic data. That's a reversal from his stance two weeks ago when he pledged action only “in case of adverse contingencies”. USDJPY continues to face resistance at 108.80.

The combined news led to a jump in global equities, including 1% in the S&P 500 and 2% in most European bourses. The challenge now is that markets are pricing in both lower rates and a detente in the trade war. In reality, the Fed will be pained to cut rates if a China-US deal is on track. An insurance-style cut would still be possible but not the 3-4 cuts over the next year that are priced into the market.

Will Fed patience pay?

After having shifted to a neutral stance at the start of the year, the Fed is expected to make a gradual shift towards a dovish stance -- But how far they go will determine how markets react. The majorty of US data sets over the last 6 weeks have come in below expectations, and the US CITI Economic suprise index has trailed all other major indice (see chart here). 

For the Fed, 'patience' is key. Recent statements have indicated the FOMC would be 'patient' in determining what moves come next. If that's removed, it's a strong signal that a rate cut is coming in July. Nonetheless, it may be paired with conditionality and the lack of an explicit signal may leave markets disappointed. The conditionality could relate to the trade war, inflation data or the economic more broadly. With the market already pricing in a nearly 90% chance of a cut, anything less than virtual promise could give the US dollar a lift against the yen, while hurting risk appetite more broadly.

Officials may also use a fresh set of projections along with Powell's press conference to tweak the message. The central tendency of the Fed funds projection is 2.4-2.9% at the end of 2020 and 2.4-2.6%. Both of those will undoubtedly be revised down, but will need to at least match the lower end of the 2.25%-2.50% range to keep the market happy.

We must also watch the inflation forecasts and Powell's conference and the extent to which he refers to slowing inflation as transitory. Overall, the market has priced in an aggressive path from the Fed that would be akin to capitulation of the Fed's long-standing hawkishness and optimism. It may be too early for that and the knee-jerk risks are towards disappointment. At the same time, Powell will attempt to keep a cut on the table and highlight that it will be in play if risks materialize. That may be enough to halt any reactionary moves quickly. A new trade for Premium Insights clients is due hours before the Fed decision.

Pound rallies on Stewart ahead of 3rd Ballot

Elsewhere, the pound rebounded from five-month lows as staunch Brexiter Dominic Raab was eliminated from the PM and the Party leadership and PM race. GBP-friendly candidate Rory Stewart continued to be the fastest gainer (but not the one with the highest standing) and is rumoured to be forming a joint-ticket with Michael Gove.

Another vote takes place today around 6pm London time, with Stewart and Javid most-vulnerable to be nixed next. Earlier today, GBP edged up even as UK CPI slipped to 2.0%  from 2.1%. Another disappointment would give Carney a reason to soften his warnings that the BOE is expecting to hike more than the market.