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The Federal Reserve is expected to use its monetary policy decisions on Wednesday to send a message that the economic outlook remains strong enough to handle further interest rate hikes despite woes in the banking sector.
This market-affirming message, along with remarks stressing that the banking system is sound and the Fed is ready to provide liquidity will be aimed at bolstering confidence.
Read: Fed likely to hike interest rates this week
So far so good.
But the Fed also has to provide its forecast of the future path of interest rate hikes and these might be hard for the market to digest.
“The risk is…the associated ‘dot plot’ will be a little hawkish,” said Vince Reinhart, chief economist at Dreyfus and Mellon,
That’s because the Fed’s forecast will likely show a stark difference from the market’s views.
The Fed’s so called dot-plot will likely stick to its forecast endpoint of rates at 5.1%, which implies one more rate hike in May, but it could raise the endpoint to 5.375%.
In either case, the Fed is not expected to forecast any rate cuts this year.
The market is barely pricing in a May hike but then the differences set in. Market pricing implies a rate cut as soon as June, with rates falling to 4.25%-4.5% by year end.
Economists don’t think the market will be convinced.
“It is highly doubtful that the these dots are going to reverse the tide of rate cut expectations that are currently prices into the front-end of the market, but policymakers are going to use the dots to affirm getting inflation back down to 2%,” said Aneta Markowska, economist at Jefferies, in a note to clients.
That’s ok with the Fed chair, Reinhart said.
Powell will try to sweeten the bitter message of more rate hikes by not trying to convince the market that it is correct.
That passive strategy was also in evidence at Powell’s last press conference in February, Reinhart said. At that meeting, Powell was pressed on the Fed’s views of higher rates for longer and replied in essence “this is our forecast, I don’t quite get why you think we’re going to ease so fast”, Reinhart said.
In the next six weeks, the data came to him and the “higher for longer” rate strategy was priced in, until the collapse of Silicon Valley Bank earlier this month, Reinhart said.
It would hurt the economy if the market moved quickly to adopt Powell’s views, Reinhart said.
“If markets snapped to where the Fed is, that would be a big tightening move”, he said
So Powell will tell the market what he intends to do and will let time arbitrate who is right, he said.
Avery Shenfeld, chief economist at CIBC Capital Markets, said investors might not be pricing in strong odds of modest rate cuts this fall.
“Instead, one can think of a world in which everyone’s base case is that the Fed hikes one or two times and then stays on hold for a couple of quarters, but that there’s a non-negligible probability that the economy goes into a tailspin and requires a major tumble in interest rates,” he said.
“That’s not unreasonable given the fog we’re operating in today, but if the fog clears as we expect, bond yields will head higher as the rate cut story gets pushed into 2024,” Shenfeld added.
Read: Pros and cons of possible Fed moves Wednesday
Stocks
DJIA,
SPX,
were up sharply in late day trading on Tuesday. The yield on the 10-year Treasury note
TMUBMUSD10Y,
rose to 3.6%. The 2-year Treasury note
TMUBMUSD02Y,
jumped by the most in a decade amid easing angst over banks.
