Federal Reserve
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All eyes are on what the Federal Reserve will announce Wednesday afternoon at the conclusion of its policy meeting.

Will the Fed taper, and if so, by how much? If it doesn’t taper, why not? And will there be any new language related to forward guidance that could impact how investors perceive the eventual taper?

With the two-day meeting commencing today, each is a legitimate question. For now, stocks are treading water as investors await some answers. The Dow Jones Industrial Average and the S&P 500 are slightly lower in morning trade. The benchmark 10-year Treasury yield is at 2.865%.

Andrew Brenner, head of international fixed income at National Alliance Capital Markets in New York, predicts there are three scenarios that could play out come Wednesday afternoon. Here are his potential outcomes, along with possible market reactions to each scenario:

1. SCENARIO: Fed keeps its bond-buying program in place, says it’s looking for more evidence to start tapering.

OUTCOME: This appears to be the most likely outcome, and the one that markets are hoping for. Mr. Brenner calls it a “classic Fed Christmas present,” which would likely cause stocks rally. The S&P 500 is riding a two-week losing streak, although yesterday’s rally recovered much of those declines. He sees a no-taper event as another catalyst that could push stocks even higher.

2. SCENARIO: Fed announces it’ll start tapering asset purchases.

OUTCOME: Mr. Brenner estimates there is a 35% chance that the central bank will announce plans to start dialing back its $85 billion-a-month bond-buying program (which is consistent with what we reported in today’s Morning M2oneyBeat.) In a recent survey, Bank of America Merrill Lynch pegged the odds even lower, saying only 11% of polled fund managers see the Fed scaling back its bond buying as soon as this week.

Mr. Brenner forecasts the knee-jerk reaction would be for stocks and bonds to drop significantly should the Fed announce a taper. He sees the yield on the 10-year Treasury note cresting above 3%, while stocks would “accelerate in downward fashion.”

3. SCENARIO: Fed doesn’t taper immediately, but outlines timeline for eventual move.

OUTCOME: Mr. Brenner sees this as the least likely scenario, although one that would likely stoke the least amount of volatility in the markets. He sees bond prices initially falling, while stock prices could rally and then pullback as investors come to the realization that the taper is definitively coming.