The Fed is unlikely to point to policy changes next week, even if the economy is stronger

Federal Reserve Jerome Powell testifies during a hearing of the Senate Banking Committee on the Quarterly CARES Act Report to Congress on Capitol Hill in Washington, USA, December 1, 2020.

Susan Walsh | Reuters

Federal Reserve officials are likely to paint a robust picture of the economy next week while not even pointing out any impending policy changes.

Investors increasingly trust central bankers when they say that even if the economy has been operating at its hottest pace in nearly 40 years, it will not take away political housing until it is clear the recovery is on solid foundations.

“The economic outlook is pretty good as long as the Fed stays on the pedals,” said Randy Frederick, vice president of trade and derivatives at Charles Schwab. “The market has finally accepted that they will.”

The Fed has kept short-term lending rates near zero since the Covid-19 pandemic began and has continued to buy at least $ 120 billion worth of bonds every month. The asset purchase has increased the central bank’s balance sheet to nearly $ 8 trillion, roughly double its level since the crisis began.

However, financial markets were suspicious that the Fed could be put under pressure to ease the accelerator given the day-to-day strengthening of economic data and mounting inflationary pressures.

“They provide liquidity that will fuel economic recovery,” said Frederick. “The challenge is that they have decided to retire on it.”

Positive outlook

It is unlikely that there will be any indication of when that date will arrive when the Federal Open Market Committee, the central bank’s monetary policy arm, concludes its two-day meeting on Wednesday.

Instead, the public is likely to receive a statement that “makes the economic outlook more optimistic” and “may turn out to be the most positive the Fed has issued in a while,” wrote Andrew Hunter, senior US economist at Capital Economics.

Like many others on Wall Street, Hunter evaluates Fed Chairman Jerome Powell and his cohorts to improve their view of the economy, but emphasizes that it is still a long way from the “substantial further progress” benchmark set by the FOMC stated in its recent statements after the meeting.

Powell recently caught the market’s attention when he said “60 Minutes” that the economy had reached a “turning point” in the recovery. However, he continued to emphasize the continued progress that the labor market needs to make to achieve full employment that is inclusive across income, race and gender groups.

Similarly, at his post-meeting press conference, the Fed chairman may want to be at least a little cautious about future policy areas, particularly regarding potential interest rate hikes and declines in the pace of asset purchases.

“Powell said he was going to be tapered. I think he will hold his cards close to his waistcoat and wait until the last minute he can wait,” said Tom Graff, head of fixed income at Brown Advisory. “I doubt the Telegraph will come this month, and besides, I think the Telegraph will come suddenly.”

There is an informal consensus on Wall Street that Powell is likely to talk about a rejuvenation starting this summer, with the expectation of a slight decline in bond purchases by the end of the year.

“They’re going to want to taper off for a while before hiking, and they’re going to want to add a little flexibility,” Graff said.

One possible rejuvenation plan

Goldman Sachs economist David Mericle said he saw some “hint of tapering” sometime in the second half of the year with a start in early 2022. He predicts the initial reduction will be $ 15 billion per session compared to $ 10 billion per session monthly pace used by the Fed during its 2014 cutback. The Fed meets eight times a year so the totals would be equivalent.

However, these details are not yet expected.

“Despite the recent acceleration, we think it is clearly too early for the FOMC to give any indication of taper,” Mericle wrote in a report for clients. “Although Chairman Powell recently began to refer to the economy as a turning point … we don’t think he means this as a signal for politics.”

If the Fed decides to rejuvenate this year, it could start a rate hike as early as the end of 2022, according to Citigroup economist Andrew Hollenhorst.

“At the FOMC in April, we expect some changes to the statement that suggest stronger data recently, but no new formal guidelines for tapering. This could come after heavy pressure on orders for April and / or May, both of which will be released in advance of the subsequent Meeting, “wrote Hollenhorst.

Traders in the federal funds futures market actually see a tiny 2.8% chance of a rate hike at next week’s session, according to the CME’s FedWatch tool. The outlook increases slightly over the course of the year, with a 10.5% probability priced in by the end of the year.

Looking ahead, the market expects a key interest rate of 0.23% or 16 basis points above the current level of 0.07% by the end of 2022. This implies a strong chance of a rate hike. The end of 2023 indicates a key interest rate of 0.42%, which corresponds to a further increase of a quarter of a percentage point.

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