Fed Chairman Jerome Powell has a difficult job in normal times, but given the market
volatility over the past week, he seems to have an almost impossible task ahead of him.
Markets are used to seeing the Fed pivot to a dovish direction in the face of turmoil — for instance in early 2016 and late 2018 — and they might expect the same to happen again. “But in neither of those instances was inflation a serious concern. That is obviously not true today,” said Tim Duy, chief U.S. economist at SGH Macro Advisors. So any dovish pivot will not be so easy this time.
Lou Crandall, chief economist at Wrightson ICAP, said the Fed would rather see the market take account for the altered policy outlook now than risk a more disruptive adjustment later.
“We doubt that Chair Powell will feel much need to make soothing noises in Wednesday’s press conference, Crandall said in a note to clients.
Marvin Loh, global macro strategist at State Street, said he thinks Powell has to “hold the party line” and indicate that the central bank plans start hiking rates in March and is hard at work on plans to shrink its balance sheet.
“There is a bit of a treading-the-needle type of environment” for Powell, Loh added. Soothing noises may only confuse markets, he said, in an interview.
But Powell does have a some room to assuage concerns of market participants about an aggressive Fed clamp down on the economy, said Duy of SGH Marcro Advisors. Despite all this talk of a hawkish Fed, the Fed’s projected rate path is shallow given the current level of inflation, he noted. For instance, the Fed’s dot-plot doesn’t have the central bank getting interest rates to a neutral setting by the end of 2024.
Powell can still make the case that the Fed won’t have to cause a recession to get inflation down.
“The statement and press conference will emphasize the need for the Fed to now focus overwhelmingly on upside risk to inflation while still holding out hope that the achievable level of maximum employment may increase in the years ahead,” said said Krishna Guha, vice chairman of Evercore ISI in a research note.
Powell will also try to avoid a sense of rushing to tighten, Guha added.
This means that none of the market’s concerns about the Fed this week will not be realized. There will not be a sudden stop to asset purchases in January, no quantitative tightening plan and nothing to fuel speculation of a half-point rate hike in March, Guha said, in a research note.
Here’s a look at what else economists and investors will be watching for when the Fed concludes the two-day meeting on Wednesday.
Markets will be watching for a signal that the Fed plans to lift off in March unless something surprising happens. Derek Holt, vice-president of Scotiabank Economics, noted that that the Fed could follow the playbook set out in its October 2015 statement just before the Fed hiked for the first time in that cycle. In that statement, the Fed said: “In determining whether it would be appropriate to raise the target range at its next meeting, the FOMC will assess progress – both realized and expected – toward its objectives of maximum employment and 2% inflation.” The key to the statement is the reference to the “next meeting.” Not codifying such intentions could inject uncertainty into March pricing,” Holt said.
The Fed could also signal that labor markets have reached the central bank’s goal of “maximum employment.”
Balance sheet management
The Fed minutes of its December meeting, released early this month, surprised the market with how detailed the discussion was about shrinking the central bank’s $9 trillion balance sheet. Those discussions are likely to continue this week and Powell will provide an update. But economists don’t expect specifics yet. “Officials have been signaling that quantitative tightening will start sooner and be implemented at a more rapid pace than last time, although that still leaves precise details unclear. Nor do we expect all the details to be settled at the upcoming meeting,” said Jim O’Sullivan, chief U.S. macro strategist at TD Securities, in a note to clients.
Optimism about omicron’s impact on growth
Economists think that Powell will repeat his earlier optimism that the omicron variant will not derail the U.S. economy.
“Optimistic isn’t the right word,” but Powell is likely to say that the soft patch that the economy is going through right now “is not going to be long-lasting,” Loh said