The Day Ahead: Fed Day

The S&P 500 experienced its biggest gain in two months on Tuesday but trading is now back in caution-mode ahead of the Federal Reserve's monetary policy statement and press conference with chairman Ben Bernanke.

The benchmark 10-year Treasury yield is almost three basis points lower in early trading at 2.951% and production MBS coupons are 6/32 better in price with the Fannie Mae 4.0 bid at 100-27.

The Euro recovered a bit overnight after Greek PM George Papandreou and the Socialist party won a confidence vote in parliament, paving the way for new austerity measures and a second financial aid package.

"Considering Papandreou made it perfectly clear ahead of yesterday's vote that he would push for new austerity measures in order qualify for a second bailout package, it would appear that he should have enough support to pass the measures," said economists at BMO Capital Markets.

Global financial markets don't seem to be convinced that this vote of confidence in Papandreou will be enough to save Greece from defaulting on their debt though. Since making modest positive progress overnight, the Euro is now 0.17% weaker vs. the U.S. dollar and Greek debt spreads have largely failed to rally against U.S. Treasuries (rally stalled at 1,304bp technical resistance).  And S&P 500 futures are 2.50 points lower at 1,285.50 and Dow futures are 21 points lower at 12,067. The market had been improving for the prior four days.

Key Events Today:

12:30 - Following a recent speech wherein Fed chairman Ben Bernanke strongly implied that a third round of quantitative easing would not be in the monetary cards, the FOMC Meeting Announcement could be key in setting the market's tone in the days ahead.

"We think the Committee will adopt more ambivalent language about the labor market and current economic activity but will reiterate that it expects a faster pace of growth to resume in the months ahead," said economists at Nomura Global Economics. "The FOMC is also likely to acknowledge that 'measures of underlying inflation' have increased but remain below the rate considered consistent with the dual mandate."

Economic data has only become worse since the late April meeting: unemployment rose from 8.8% in March to 9.1% in May, core consumer price inflation climbed from 1.2% to 1.5%, and GDP estimates fell to a 1.5% to 2% range.

Nomura believes the policy statement must reflect those changes, as the previous one called said recovery was "proceeding at a moderate pace" and it called labor markets "improving gradually."

Bernanke's comments on June 7, that the recovery has been "frustratingly slow," is a little more up to date.

"The key questions will be about how the Fed views the present combination of weak growth and higher-than-expected inflation," said IHS Global Insight. "Does the Fed still expect growth to pick up after a soft first half? Is it still confident that the upward creep in core inflation will be contained? And what would be the trigger points for growth or inflation that would make the Fed change the status quo - either to pump in more quantitative easing, or alternatively to start shrinking its balance sheet and preparing for a rate hike?"

2:15 - Fed chairman Ben Bernanke holds a post-FOMC meeting press conference to elaborate on the policy statement. The Fed's Summary of Economic Projections will also be released at this time. MND expects the Fed to further downgrade their 2011 economic growth forecast. Currently the Fed is projecting 3.1 to 3.3% growth in 2011. MND sees the Fed lowering their outlook to 2.5 to 2.9%.