Wednesday's Fed Decision Could Catch Markets Off-Guard

On Tuesday and Wednesday the Federal Open Market Committee will meet to discuss future monetary policy. The decision the FOMC reaches may dictate the flow of the U.S. economy for the remainder of the year. According to The Wall Street Journal, the general consensus from economic commentators is that there will be no additional rounds of quantitative easing. Last week, in a poll conducted by Bloomberg, it was found that the majority of Forex professionals do not anticipate QE3. The Fed's second round of quantitative easing is set to end next week on June 30th. As of now, Fed officials have been consistent in stating that there are no plans in place for QE3. Recent economic data would seem to indicate that the U.S. economic recovery is slowing. Given this, is it likely that the FOMC decides to change direction? Despite poor economic statistics, the Fed is hamstrung by recent inflation data. Though the price of oil has receded from its recent highs, inflation numbers released last week indicate that core inflation has begun to rise. Generally speaking, the Fed uses core inflation when making future policy decisions. A rise in core inflation might be interpreted by Fed policy makers as a signal that additional QE could send inflation spiraling out of control. Though some are warning of a Japanese-style lost decade should the Fed fail to act, the stagflation presently being experienced by those in the U.K. might stand as a dire warning to the dangers of excessive easing. Still, many believe that, even if it fails to materialize at the present time, QE3 is largely inevitable. Famed commodities investor Jim Rogers stated that the Fed will bring back QE, but they may attempt to disguise it, according to MoneyNews. "They may not call it that. They may call it 'cupcakes.' Who knows what they'll call it, but it's coming back," Rogers said. Action Items Bullish: Traders who believe that QE3 is about to be unveiled might want to consider the following trades:

• Buy SPDR Gold Trust GLD in a long play on gold. Gold rallied following the implementation of QE1 and QE2. If the trend holds, gold may rally following QE3.
• Buy Pro Shares Ultra Pro Dow 30 UDOW in a long play on the Dow Jones. The markets have rallied sharply since QE2 was implemented, if QE3 is implemented, they may rally further.

Bearish: Traders who believe that the Fed will hold off and allow the economy to run its course may consider taking positions in the following:

• United States Short Oil Fund DNO is a short play on oil. Without additional monetary stimulus, the economy may contract. A contracting economy might weaken the demand for oil.
• Pro Shares Ultra Short Dow 30 DXD in a leveraged short play on the Dow Jones. If the economy is contracting, the market may contract as well, and DXD may rally.

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