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New Economic Variables Confound Fed’s Future Path
Federal Reserve Chairman Jay Powell tends to tell the markets exactly what to expect from the Fed. Last week he said he’d propose raising interest rates by 25bp (up from 0.00-0.25) after the March 15-16 FOMC meeting. This would be the first increase since 2018. Earlier this year, Powell set expectations for the possibility of raising rates by twice as much; he also suggested the Fed might need to eventually raise borrowing costs to a level designed to deliberately slow economic growth. This was the chairman’s thinking before the war broke out in Europe. The uncertainty of its impact on growth here in the US is the main reason to be cautious now. What are the variables?
While the Fed Chairman is just one of 12 voting members, past FOMC meeting minutes show that the vote on monetary policy change, after debate and deliberations, most often goes along with the Fed Chairman’s judgment. Prior to the war-related global economic upheaval, the big risk was inflation caused by a number of variables, including tight labor markets, supply chain problems, raw material shortages, etc. A 0.50% hike could have added enough pressure on the economic brake pedal to temper some of these price pressures while letting other problems such as shortages work their way out of the system.
The market was pricing itself for 0.50% prior to the invasion of Ukraine, now a 50bp hike would surprise and disrupt the markets. While market levels are not part of the Fed’s mandate, a severe downturn in stock and bond markets could pummel spending and economic growth. So, the Fed is cognizant of market reaction. And with recent uncertainty, likely to err on the side of doing too little.
Decision and Outlook
If not for the international upheaval of unknown length and consequences, a half percentage hike would have been the most likely action after this meeting. But after Powell’s more recent comments, the decision on what to say after the rate announcement is likely the bigger decision at the meeting. In 2022 we are accustomed to an extremely overt Fed, anything but clarity and confidently setting expectations will leave markets uneasy.
The last time inflation was running in 8% territory (decades ago), the Fed did not signal its intentions, nor did it announce a change. Its actions backe then were just another variable in the market that participants needed to analyze and speculate on. If it eased or tightened was not certain until the FOMC meeting minutes were published three weeks after the next FOMC meeting. And the rate changes were most often between meetings. The need to guide expectations and fear of catching the market off-guard was not a part of any decision. Secrecy and being covert was its own powerful tool.
Today all involved want to be told what to expect, and when. Currently, the markets (stock, commodity, real estate, currency, and bond) are pricing themselves for the 0.25% expectation newly set by the Fed Chair. But speculation is running high on the guidance statement that follows the two-day meeting. The interest-rate path that is signaled will indicate the US central bank’s best evaluation of the most likely economic outlook. And the updated outlook in the face of stiff economic sanctions with trading partners, which could slow the US economy and at the same time add to some root causes of inflation, is highly anticipated. The markets want to know what the Fed sees and what it views as its path.
The Fed Announcement will be the most important in nearly two years. Three months ago, almost all Fed voting members indicated they felt a need for between two and four rate rises this year. This has changed, we’ll learn by how much soon.
The market has expectations that the Fed will raise rates 25bp and the market reaction at this point, if that is the level, will be minimal. Perhaps relieved. However, the announcement following at 2 pm, Wednesday (March 16) is likely to show that Fed officials are on guard for either weakness related to changed global circumstances or strength based on recent US economic numbers. This is what is most anticipated.
What is certain about the statement afterward is the Fed will sound confident in its assessment; uncertainty would roil markets further.
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