Jerome Powell, Chairman of the Federal Reserve Board, delivers a news conference following the announcement that the Federal Reserve has raised interest rates by half a percentage point, at the Federal Reserve Building in Washington, the United States, December 14, 2022.
Evelyn Hockstein Portal
The Federal Reserve is expected to hike interest rates by just a quarter point, but is also likely signaling that it will remain vigilant in its fight against inflation even as it scales back the size of the hikes.
The Fed will release its final rate decision Wednesday at 2pm ET and Fed Chair Jerome Powell will brief the media at 2:30pm. The expected quarter-point hike follows a half-point hike in December and would be the smallest hike in the federal funds target interest rate range since the cycle’s first hike last March.
While the meeting is expected to be relatively uneventful, strategists say it could be a challenge for the Fed chair to soften the reaction in financial markets. Markets are higher as investors expect the central bank could allow the economy to land softly while dampening inflation enough to return to policy easing.
“How is he going to tell people to calm down, relax and not be so excited as we near the end of rate hikes?” said Peter Boockvar, chief investment officer at Bleakley Financial Group. “He’s going to do that while still saying the Fed will stay tight for a while longer. Just because it’s done doesn’t mean it’s a quick bridge to relaxation.”
The Fed’s rate hike on Wednesday would be the eighth since last March. It would set the Fed Funds’ target rate range at 4.50% to 4.75%. That’s just half a percentage point away from the Fed’s estimated endpoint, or range, of 5% to 5.25%.
“I think he will push back on the financial terms. I think markets are expecting that. I think people are realizing how much credit spreads have moved, how much the stock market has moved, how much technology stocks have moved. This month has been exceptional,” said Rick Rieder, BlackRock’s chief investment officer for global fixed income.
A rally that could dampen Fed efforts
Easy lending and a too-fast stock market could derail the Fed’s efforts to cool the economy and curb inflation.
Stocks rallied Tuesday as the Fed began its two-day meeting, capping January’s nearly 6.2% gain for the S&P 500. The technology sector was up 9.2% for the month. Yields have fallen since the end of the year, with the benchmark 10-year Treasury yield at around 3.5%, down from around 3.9% in December.
Rieder expects Powell to deliver his comments with a hawkish tone. “I think if he’s hawkish, the markets have built that in. I think if it’s not, the market might take another leg,” he said.
In the futures market, fed funds futures continued to price a trailing rate of less than 5%. The futures also show that investors expect the Fed to actually reverse policy and cut rates by at least 25 basis points by the end of 2023. One basis point corresponds to 0.01 percentage points.
“I think it’s going to be tight relative to market prices,” said Jim Caron, head of macro strategies for global fixed income at Morgan Stanley Investment Management.
Caron said the Fed’s rate hike cuts are viewed as inherently dovish. Before the 50 basis point hike in December, the central bank hiked rates four times in a row by 75 basis points.
“He wants to defend the validity of the final rate of 5% to 5.25% [forecast],” Caron said. “At the same time, he sees record house prices falling. Wage inflation is falling. The auto sector is not doing well. Retail isn’t doing so well. The labor market is doing well. Wage inflation is declining, but it’s still above comfort levels.”
Listen carefully to the Fed’s messages
Caron said Powell also wanted to be careful not to sound too hawkish. “It’s very easy for the Fed’s communication to make a mistake, or there could also be a mistake in the way the market interprets things initially,” he said. “That tells me there’s going to be a lot of volatility.”
Investors will be tuned in to any comments Powell makes about the economy and whether he expects it to slide into recession as many economists are predicting. The central bank forecast no recession in its forecast but expects very sluggish flat growth and sees the unemployment rate sharply rising to 4.6% later this year from December’s 3.5%.
The Fed is not expected to make any major changes to its policy statement when it announces the rate hike. Its latest statement said that “ongoing increases” in the target interest rate range are appropriate to reach a policy position that can bring inflation back to 2%.
The Fed is making strides against inflation. Core personal consumption spending rose 0.3% in December and came in at 4.4% on an annual basis, up from 4.7% in November, the slowest rise since October 2021
Strategists say the Fed needs more data and will likely wait until at least March to signal how long it could continue raising rates. If it stays the same pace, there could be two more quarter-point hikes.
The Fed will not release any new forecasts or economic forecasts on Wednesday. The next forecast is the quarterly release of economic forecasts at the March meeting and this is one way markets will get more clues as to the intended rate path.
“They don’t want financial conditions to relax too much and they don’t have any new guidance to give, so I think what that means is that you have fewer changes to the statement and that line about ‘ongoing increases’. will stay the same,” said Michael Gapen, chief US economist at Bank of America.
Gapen said it will be difficult for Powell to sound too hawkish. “Actions speak louder than words. When they slow down [the size of rate hikes] For the second meeting in a row, it’s hard to back that up with overtly hawkish language,” he said.
Boockvar said Powell should stress that the Fed will keep rates higher despite market views that it will cut rates soon. “Powell is more focused on getting inflation to come down and stay low than trying to help the S&P 500,” Boockvar said. “His legacy will not depend on where credit spreads are or where the S&P is headed. It will depend on whether he beat inflation and it stayed low.”