The Fed must go a tremendous line on Wednesday as monetary markets keep in stability
Federal Reserve Chairman Jerome Powell speaks to reporters after the Federal Reserve cut interest rates to protect the world’s largest economy from the effects of the coronavirus during a news conference in Washington on March 3, 2020.
Kevin Lamarque | Reuters
A resurgent economy, pervasive inflation, and a surge in stock markets don’t seem like a good recipe for easy monetary policy.
But in that position is the Federal Reserve.
The challenge for the central bank this week will be to explain this position to investors and reassure them that even if the status quo persists, it will not, and should, change policy makers do not do.
“The baseline is, ‘Everything looks a little better, but there is still a lot of uncertainty and we’re not going to do anything anytime soon.’ I’m sure we will hear that, “said Bill English, former head of monetary affairs at the Fed and now professor of finance at the Yale School of Management.
“You want to suggest that things are better,” he said. “On the other hand, they don’t want to suggest that they change the guidelines anytime soon. So it’s a difficult communication.”
The Federal Open Market Committee, which sets monetary policy, will meet on Tuesday and Wednesday, followed by a press conference by Fed Chairman Jerome Powell.
Nobody expects changes in broad terms. Short-term lending rates will remain near zero and the Fed will continue to buy at least $ 120 billion worth of bonds every month to keep market flow and financial conditions relaxed.
There will be plenty for investors to chew from this meeting.
Economic forecasts due
Eddie Rodriguez, who works for the City of Hialeah, distributes jobless claims to people in their vehicles on April 8, 2020 in Hialeah, Florida.
Joe Raedle | Getty Images News | Getty Images
On the one hand, individual members will update their forecasts for gross domestic product, unemployment and inflation.
They last made estimates in December before Congress approved two stimulus packages totaling nearly $ 3 trillion and before a Covid-19 vaccine was introduced, which vaccinates 2.4 million Americans every day.
Goldman Sachs recently raised its full-year GDP forecast to 7% and also sees unemployment falling faster than expected as inflationary pressures mount.
In contrast, the Fed’s December summary of economic forecasts came up with a median estimate of just 4.2% for GDP, plus a forecast for the unemployment rate of 5% and core inflation of around 1.8%.
According to Bank of America, these numbers are likely to experience “significant upward revisions”.
The Bank of estimated that GDP could be raised “at least” 1.5 percentage points to 5.7% to 6%, while unemployment could be lowered to 4.8% and inflation could be raised to the Fed’s 2% target America.
Inflation has already become a problem for the Fed. Soaring bond yields and market prices rise one measure to their highest level in nearly 13 years.
In a note earlier this week, the bank’s economic team described the meeting as “one of the most critical events for the Fed in a while”.
Powell “needs to strike the right balance” between an optimistic economic outlook and the Fed’s willingness to let inflation run hotter than usual to ensure job gains are broad and include income, race and gender, Bank of America notes.
Powell could take the opportunity to make some incremental policy adjustments.
“This is likely to be the Fed’s first step in the less accommodative direction as it creates the conditions for rejuvenation and eventual policy tightening,” the note reads.
Hawkish tilt possible
Federal Reserve Chairman Jerome Powell speaks during a virtual press conference in Tiskilwa, Illinois, United States on Wednesday, December 16, 2020.
Daniel Acker | Bloomberg | Getty Images
For the past few weeks, markets have speculated that the Fed would adjust its bond purchases to lower longer-term interest rates, which this year have soared to pre-pandemic levels and caused volatility in the equity markets.
Powell pushed that thought back.
Investors will use the Fed’s scatter plot of individual member expectations to see how broad the consensus is for an indefinitely unchanged approach.
“Everyone is supposedly on board the new framework, but it may not mean the same thing to everyone,” said Tom Graff, head of fixed income at Brown Advisory. “That could not mean [some members] are as hawkish as they see that this average inflation target regime will work differently than perhaps Powell. “
The market could thus decipher which political “points” are moving in the direction of rate hikes. According to Citigroup, the market is already anticipating the possibility of increases in late 2022 and a total of three by the end of 2023. Current estimates by the Fed assume that no changes will be made until at least 2024.
You want to suggest that things are better. On the other hand, they don’t want to suggest that they change the guidelines anytime soon. So it’s a difficult communication.
Finance Professor at Yale School of Management
“It’s going to be interesting because how do you improve your GDP projections to 7% and your inflation target to 2% and your unemployment forecast to 5% and then say we’re going to be super easy,” said Kathy Jones. Chief Fixed Income Strategist at Charles Schwab. “What you want to emphasize is patience.”
Jones said she was not expecting any policy change just yet, with Powell stressing the importance of “maximizing and inclusive increases in employment and decreases in unemployment before they even consider raising interest rates.”
“They’re pretty comfortable waiting for it,” she said.
English, the former Fed official and Yale professor, said Powell would stress “uncertainty” despite advances with the virus and the economy.
“Part of the communication will be:” Our response function has not changed. We still want to achieve our goals, we will still be patient, “he said.” The most likely prospects are better, but the world is an uncertain place. A lot can happen. “