The FOMC meeting that concludes on Wednesday is expected to leave monetary policy unchanged. But there are many factors that could move the markets in the aftermath. One salient point is that this is likely to be Fed Chair Jerome Powell’s last time presiding over the meeting, and traders will be looking for clues about the Fed’s next move.
On this occasion, the Fed will not update its dot-plot matrix or provide an economic outlook. Traders will have to rely on their interpretation of the language in the statement, particularly Powell’s comments after the meeting. This introduces an element of subjectivity and could lead to greater volatility in the markets immediately afterwards, as traders try to figure out what it implies for the future of monetary policy.
The Odds For a Cut
Markets are pricing in a 100% chance of another hold, and around a 40% that the Fed will cut rates by the end of the year. How those odds shift will likely determine the market’s reaction. Economists generally agree with the Fed that there will be one more rate cut this year. The markets are worried that inflation will prevent the Fed from easing.
The main issue is uncertainty, and that largely hasn’t been resolved. At the last meeting, the Fed voted to keep policy unchanged and wait for data on how the war in the Middle East is affecting the economy. This neutral stance contrasted with the more dovish stance that had been the norm before the war, leading the market to adopt a more hawkish view of Fed policy over the last month.
The Lack of Clarity Can Shake Up Markets
The problem for Fed watchers is that uncertainty remains, even with more data. The key point is whether the higher energy prices resulting from the closure of the Strait of Hormuz will be transitory. As time goes by, the impact will increase. But we don’t know how long it will remain closed, since at any moment Washington and Tehran could announce they’d reached a deal.
If the Strait remains closed, crude prices will likely be near $100/bbl (WTI is the pricing basis in the US). That would introduce as much as 300 bps of inflation over the next several months, meaning the Fed would have to raise rates to stabilise consumer prices. But if the Strait were to open tomorrow, core inflation might be affected by one or two decimal places for a couple of months. Potentially, crude prices could collapse to below pre-war levels, and make the case for the Fed to cut even faster.
What the Fed Can Do to Affect the Markets
At this point, the Fed doesn’t know which of those scenarios will play out, so it has to keep rates unchanged. The next meeting isn’t until June, and by then, three months of post-Hormuz closure data will become available. And Keven Warsh, widely expected to be more dovish than Powell, will chair the meeting. This leaves considerable uncertainty after Wednesday’s FOMC decision.
Markets will likely take less account of Powell’s tone and focus more on whether the FOMC’s emphasis is on inflation or the economy. If it’s the former, markets could firm up their expectations of no rate cuts this year, supporting the dollar while weakening gold. If the economy is the focus, particularly if higher costs dragging on the economy is mentioned, then it could be seen as dovish, weakening the dollar and supporting old.
