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Financial markets seem almost giddy these day on expectations that inflation is going to turn out to be transitory after all and that the Federal Reserve will be able to pause rate hikes in the spring and lower interest rates before Thanksgiving.
Some economists think that Fed Chairman Jerome Powell will want to push back on the idea that the central bank is about to pivot.
They argue that falling bond yields and otherwise loosening financial conditions will actually will increase inflation pressures.
See: The Fed and the stock market are on a collision course this week
“Bond market moves…mean the Fed will have to hike more,” says Avery Shenfeld, chief economist of CIBC World Markets.
These economists expect the Fed to hike at least until May.
But there is another school of thought.
Some economists note that easy financial conditions are not the worst thing when you have an economy that continues to flirt with recession. And they think inflation trends give the central bank the ability to pause as soon as March.
All sides agree a quarter-point interest-rate hike on Wednesday is a foregone conclusion. That will bring the Fed’s benchmark rate to a range of 4.5% – 4.75%.
Read: Fed set to deliver quarter-point hike
The Fed will release a policy statement at 2 p.m. Eastern on Wednesday, followed by Powell’s news conference at 2:30 p.m. There will be no updated forecasts of the economy or interest-rate expectations after this meeting. Those will come in March.
Changes to the policy statement are likely to pack more punch than what Powell has to say at his news conference, said Krishna Guha, vice chairman of Evercore ISI.
Here’s a look at four ways economists think Powell can be hawkish — a term used to describe central bankers more worried about inflation than economic growth — if he wants to be on Wednesdsay:
‘Ongoing increases’
In December, the Fed statement said that Fed officials anticipated “that ongoing increases in the target range will be appropriate.”
While continuing to use the plural “increases” might be the easiest, and hawkish, thing to do, Michael Feroli, chief U.S. economist at JP Morgan Chase, thinks a good case can be made to qualify that phrase.
He thinks the Fed will modify the language to say that ongoing increases “are likely to be appropriate.”
Guha of Evercore says Powell will worry that retiring “increases” could be seen as pre-signaling a pause after March.
“So he may well decide to play it safe and leave the statement formula alone while fine-tuning the message in the press conference, or compromise on ‘additional increases’ — more than one but not necessarily ‘ongoing,’” he said.
Taking aim at easing of financial conditions
In the minutes of the Fed’s December meeting, officials were worried that “an unwarranted easing in financial conditions, especially if driven by a misperception by the public of the [Fed’s] reaction function, would complicate the [Fed’s] effort to restore price stability.”
“If the Fed wanted to add a hawkish spin to Wednesday’s announcement it could add forward guidance language that reinforce the Fed’s economic projections suggesting that rates won’t begin to fall again until well into 2024,” said Paul Ashworth, chief North America economist at Capital Economics.
Emphasizing no rate cuts expected this year
The minutes of the Fed’s December meeting also underscored that none of the central bank’s top 19 officials “anticipated that it would be appropriate to begin reducing the federal funds target in 2023.”
Diane Swonk, chief economist at KPMG, thinks that Powell could repeat this sentiment at his news conference.
“Powell has got to come across as resolved,” Swonk said.
Shifting the dots
Once every three months, Fed officials publish their expectations of the path of interest-rate policy, knows as the “dots.”
In December, the median forecast of Fed officials was for the Fed’s target range to rise to a range of 5%-5.25% this year. At a quarter-point pace, that would mean rate hikes end in May.
Last year, before the “dots’ were published, Powell signaled that officials were ready to move their dots higher than they had planned in September.
Derek Holt, head of capital markets economics at Scotiabank, thinks it could happen again,
“I think Powell may repeat his line about how the dots may shift higher again in March,” he said.
Stocks
DJIA,
-0.25%
SPX,
-0.79%
were lower on Monday while the yield on the 10-year Treasury note
TMUBMUSD10Y,
3.554%
rose slightly to 3.54%. But yields have pulled back significantly from their fall highs, while the S&P 500 and Nasdaq ended Friday at highs for the new year.
See: Tech stocks are having their best January in decades — here’s why that may not be a good sign
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