There are a lot of market expectations ahead of the FOMC’s meeting which concludes tomorrow. We’ve been seeing swings in the markets lately, including unusual behavior from US stocks on Monday. These are largely due to changing expectations over what the Fed might do.
Given the jobs numbers and increasing inflation, there is a lot of speculation as to what could happen at the Fed’s first meeting of the year.
Nonetheless, it should be noted that most analysts are inclined to agree that no specific policy change will happen. Rather, Chairman Powell will try to sound as hawkish as possible during the press conference. But, many economists are hedging their bets, suggesting varying degrees of possibility for different potential policy changes.
What could happen?
After the disappointing jobs report in December, many analysts pulled forward their estimation that the Fed will hike rates in March. That also seems to be the consensus of the money markets.
The current pace of the taper means that by mid-March, the Fed will stop buying assets, and then almost immediately raise rates. Note that the next Fed meeting is in March.
For this reason, many analysts suggest that the way for Powell to take a hawkish stance without actually changing policy is to communicate that they will likely raise rates at the next meeting. There is a pretty strong notion that the Fed will telegraph a rate hike at least one month ahead of it happening.
So, if Powell doesn’t give a clear indication that rates will rise in March, the markets might delay their pricing for the rate hike, leaving it for April. That could cause the dollar to weaken. And we could get a bounce in stocks.
The less likely scenarios
Some analysts have suggested that the Fed could outright stop buying assets after their meeting, effectively completing the “taper”. Generally, this would be an extremely hawkish move. And it might even cause the stock market to take another leg lower.
However, the analysts proposing this outlook say that there is a “less than 1-in-4 chance” of this announcement happening. Even less likely is the potential that the Fed could come out and announce a rate hike, even before completing the taper.
The general idea among economists is that interest rates have a bigger impact on inflation than asset purchases. That led to the suggestion that the Fed should raise rates while continuing to buy assets, in particular, MBS. But, that doesn’t appear to be the direction the Fed is headed towards, and if it were to happen, it would thoroughly shock the markets.
There’s nothing more to do
In a note to clients, Blackrock suggested another way of looking at this: if supply chain problems cause inflation, the Fed is powerless to deal with that problem. Turning off the money spigot while businesses are struggling to pay for increased costs would have a boomerang effect and adversely impact businesses while doing little to stop inflation.
However, this does not appear to be the Fed’s plan, when they basically have only one tool to use in fighting inflation. And with inflation being high, they feel obliged to use it – regardless of how the market might react.
Even though most of the market is pricing in a more hawkish tone from the Fed, it might still react negatively to the results of the FOMC meeting and press conference.