- Markets have priced in a nearly 100% chance that the Fed will approve a quarter-point hike at its two-day meeting on Wednesday.
- Where the intrigue comes into play is how the central bank proceeds from here.
- According to Goldman Sachs, economic and market-related cross-currents will lead to the Fed signaling a policy shift this week.
- While the market is anticipating a “dovish” Fed inclined to halt rate hikes and start cutting later this year, stubbornly high prices could change that.
Jerome Powell, Chairman of the Federal Reserve Board, speaks during a press conference at the Federal Reserve in Washington, DC, March 22, 2023.
Olivier Douliery | AFP | Getty Images
There won’t be many secrets about what the Federal Reserve will do with interest rates on Wednesday. Where the intrigue comes into play is how the central bank proceeds from here.
Markets have priced in a nearly 100% chance that the rate-setting Federal Open Market Committee will approve a quarter-point hike at the end of the two-day meeting. This is the 10th hike since March 2022 and brings the Fed’s interest rate to a target range of 5% to 5.25%.
For investors, the tricky part will be what happens next: will the Fed signal that it’s done raising rates, or will it leave open the option to tighten even more if it thinks more needs to be done? to fight inflation?
“What matters most is how they convey the potential for a future pause,” said Collin Martin, fixed income strategist at Charles Schwab. “How do they do that while probably also leaving the door open a bit? That will be a balancing act between assuming a pause is on the horizon, but still dependent on incoming data if inflation picks up in the future.”
Several factors will come into play as Fed Chair Jerome Powell and his colleagues indicate where monetary policy is headed.
Inflation was the focus of official thought. Recent indicators point to moderation, but only to levels still well above the Fed’s 2% target.
For example, the Dallas Fed compiles a measure called the “trimmed mean” of personal consumption spending, which essentially gives high and low readings. That shows annual inflation of around 4.7% in March, little changed since August 2022 and up from a pace of 3.9% in March 2022. The consumer price index was 5% in March compared to 8.5% a year ago.
None of these figures are satisfactory for Fed officials.
Regardless of the measure, inflation “is still way too high and that’s not the end of my job,” Fed Governor Christopher Waller said in an April 14 speech. “I interpret this data to suggest that we haven’t made much progress on our inflation target, which puts me about the same place on the economic outlook as we were at the last FOMC meeting and on the same path for monetary policy leaves. “
But the Fed has another consideration that has drawn a lot of market attention, namely the nagging troubles in the financial world that hit another bank earlier this week when JPMorgan Chase acquired First Republic, the 14th largest Bank of the country by assets.
Then there’s the economy. A looming recession appears to be looming as gross domestic product grew just 1.1% yoy in the first quarter and there are signs of rupture in the labor market.
All of these cross-currents will result in the Fed signaling a policy shift this week, according to Goldman Sachs. The company’s economists expect the FOMC to adjust the language in the post-meeting statement to indicate an upcoming change.
“The focus will be on revisions to the forward guidance in his statement,” Goldman economist David Mericle said in a note to clients. “We expect the committee to signal that it expects a pause in June but maintains a hawkish bias and exits earlier than originally planned as bank stress is likely to lead to a credit crunch.”
A hawkish bias means that Fed policymakers will emphasize that interest rates must remain tight, even though no further hikes may be imminent. The aim would be to maintain the central bank’s anti-inflation credentials while acknowledging the other strains and ability to now simply let previous increases run their course through the economy.
In the part of the statement where the Fed provides guidance, Mericle expects a sentence that might look something like this: “The committee believes that monetary policy stance will most likely be sufficiently restrictive to keep inflation at 2 percent, but will closely monitor the incoming information and assess the impact on monetary policy.”
While the market is anticipating a “dovish” Fed, poised to halt rate hikes and start cutting rates later this year, persistently high prices could change that.
Inflation has proved more stubborn than expected, as confirmed by the Atlanta Fed’s “sticky price” CPI, which compares prices of goods and services that don’t change much over time to those that do.
Sticky prices rose 6.6% annually in March and are generally on the rise, while the flexible price CPI rose just 1.6% and has fallen precipitously from its 19.7% peak in March 2022. Sticky prices include residential properties.
At least those kinds of numbers will keep the Fed on high alert lest it ease too soon.
“Most Fed officials don’t seem comfortable that the rate-hike cycle is over,” Citigroup economist Andrew Hollenhorst said in a note. The Fed’s next meeting is in six weeks, June 13th and 14th, and the April CPI report is due in a week, on May 10th.
“The middle of the committee recognizes the unknown macroeconomic impact of the credit crunch and keeps the potential need for further rate hikes on the table,” Hollenhurt added. “And recent data has not been reassuring when it comes to bringing inflation under control.”
In fact, at this week’s meeting, Citi sees not only a hike, but additional rate hikes in June and July before the Fed finally pulls out.
“Chairman Powell’s statement and press briefing should be mostly about reaffirming the political path [will] data-dependent rather than leading to a predetermined political path,” wrote Hollenhorst.
Coupled with the delicate balance of how to wire the rate hike, there could be some disagreement among Fed officials, who are generally moving in unison. Comments since early March reflect diverging views between those who expect policy change and those who still see inflation as the top priority.
“Will this be the one-off Fed meeting?” said Quincy Krosby, chief global strategist at LPL Financial. “There are disagreements within the Fed. It’s public. You can only imagine what the internal debate is like. … This Fed meeting is crucial.”