Expect more explanations from Powell on Wednesday. The market expects the Fed to keep rates on hold, and the statement will be carefully scrutinized for hints on the two more hikes officials forecasted last December.

Since December the outlook has been clouded by global growth as well as the US government shutdown. Interpreting the statement carries high risk of misinterpretations.

Global economic uncertainty index continues spiking.

The Fed has to balance expectations, on one hand explaining the responsiveness to any softness in the economy, and on the other hand managing expectations that the economy is relatively sound, with “some” hikes rather likely. “They” better have Powell prepared, so he does not repeat the “communications miss” from December.

(We ask ourselves how the Fed will be able to even say anything definitive about some crucial stats as they haven’t even been able to see the stats due to the US government shutdown)?

Fed needs not only to address the economy and the outlook, but the balance sheet as well. QT is very much alive, but managing it on autopilot is not an easy task. Expect Powell to be pressed for more details on the balance sheet topic. Powell can’t risk anything but to really “nail” this communication.

With the violent bounce in equities and the recent implosion in volatility, the prudent investor should look at ways to hedge (or speculate) via relatively cheap optionality in most markets. The long-term average of VIX is lower, but remember the VIX tends to trade in both “normal” but also “elevated” volatility regimes. If the past month’s elevated VIX is a new regime or not is to be seen, but given the extremely uncertain upcoming Fed event on Wednesday, VIX doesn’t look overly expensive here.

VIX volatility regime change?

We remind you of the last note from JPM’s Kolanovic:

“If the balance sheet reduction is a signal to sell, volatility increases, liquidity decreases, and additional systematic flows are triggered. Balance sheet driven market fragility is thus increasing the risk of market disruptions and ultimately the risk of a recession – which is in contrast to policy makers’ intentions.”

VIX 1 year chart.

Source: charts by Bloomberg