Fed’s Forward Guidance
It will be all about the Federal Reserve on Wednesday. Because inflation is staying higher than projected, the central bank is torn between a “hawkish” and “dovish” view.
Most people think that the Federal Open Market Committee, which sets policy, will keep interest rates the same at between 5.25% and 5.50% for a fifth meeting in a row. Also, officials will update their economic and rate expectations for the first time since December. This could mean that they change their minds about the three rate cuts they had planned for by the end of 2024.
Still, markets and the Fed have been in a standoff for months, but it’s over now. A lot of economic data released in the last few weeks has supported the central bank’s case for caution. Fed funds futures buyers thought that rates would go down by six to seven quarter points by the end of the year in January. Now that inflation is dropping more slowly than expected, traders expect three drops starting in June or July. This is in line with the Fed’s December Summary of Economic Projections.
A rate cut is not possible at this week’s FOMC meeting or in May, according to Liz Ann Sonders, chief financial analyst at Charles Schwab. This is because inflation and unemployment have “changed significantly.” She thinks the Fed will cut rates more slowly than it raised rates quickly in 2022 and 2023.
As part of the SEP, the so-called “dot plot” will show how each Fed member thinks the standard lending rate will move. Sonders said she wouldn’t be surprised “to see up to one of the expected rate cuts this year come out,” which means the number of expected cuts will drop from three to two. This is because inflation readings are higher this year and payrolls data are still strong. Not all the numbers have been screaming inflation, though. Retail sales are down and the job market is starting to show signs of stress.
Claudia Sahm, the head of Sahm Consulting and a former Fed economist, says that the Fed probably won’t change its rate outlook because it is based on data and the jobless rate is going up. Inflation is only one to two percentage points away from the 2% goal.
It will depend on how much good data we have before we make the first cut, Sahm told Seeking Alpha over the phone. “Given the data at hand, it’s not going to depend on what Fed officials say,” Right now, she thinks there’s a chance of a cut in June, but it will depend on the data that comes in between now and then.
In a speech to Congress on March 6, Fed Chair Jerome Powell said that the central bank has made good progress in its fight against inflation and is close to its 2% goal. However, “just a bit more evidence” is needed before the first rate cut can happen. He said, “We’re not far from it.”
The news statement Powell holds after the meeting will no doubt get a lot of attention from investors. Reporters may ask him how the mix of this year’s high inflation rates and low retail sales affects his thinking, keeping in mind that the Fed’s job is to keep prices stable and ensure full employment.
Sahm can’t wait for Powell to talk about how the Fed looks at the facts. She also said that if the Fed does become more “hawkish,” Powell should explain more about what the Fed looked at in order to make that decision. That openness would then help data-driven markets figure out what to focus on, which could make the market less volatile.
If the Federal Reserve becomes more “hawkish” on Wednesday, the markets will see that as a “higher-for-longer” stance, which could be seen as “higher-until-recession,” according to Damir Tokic, an expert at SA. He thinks the FOMC will probably hint at one or two rate cuts in 2024. What the Fed might do, even if it’s just a “slight adjustment,” “is likely to cause the reversal of the speculative fever [in stocks] since the premature dovish turn in December, and thus, the [price-to-earnings] multiple contraction.”
“Of course, the Fed could do nothing, leave the SEP alone, keep the three rates for 2024 on the table, and maybe even lower its PCE [inflation] projection,” said Mott Capital Management’s Investing Group Leader. Then, “financial conditions would likely ease even further, and all bets on bringing inflation back to target would seem to be off.” This would be good for traders.
The Federal Reserve will also start talking about its $7.5T balance sheet and when and how to lower the rate at which it pulls extra cash out of the banking system. This is in addition to the rate decision. As part of what is called “quantitative tightening,” the Federal Reserve has been slowly reducing the size of its balance sheet by getting rid of stocks that are coming due.
Must read book about investing – check here Fed’s Forward Guidance Fed’s Forward Guidance Fed’s Forward Guidance Fed’s Forward Guidance Fed’s Forward Guidance Fed’s Forward Guidance Fed’s Forward Guidance Fed’s Forward Guidance Fed’s Forward Guidance