Jerome Powell, president of the U.S. Federal Reserve, speaks during a hearing of the Chamber’s Coronavirus Crisis Subcommittee in Washington, DC, USA, September 23, 2020.
Stefani Reynolds | Reuters
Chances are high that the Fed will move the markets this week, no matter how hard it tries not to.
With rising interest rates and a recovery in the economy, the Fed’s easy policies are in the spotlight, and more and more, the question becomes when it considers undoing them. Fed Chairman Jerome Powell is likely to be asked about the Fed’s low interest rate and asset purchase policies during his press conference after the two-day Fed meeting that ends on Wednesday.
Powell is unlikely to be specific, but what he says could shake the already volatile bond market and that, in turn, can boost stocks. This could mainly affect growth stocks, if bond yields start to rise.
“I think at the last press conference, I think I watched with one eye and I heard with one ear. This one I’ll be tuned to every word and the markets will be tuned to every word,” said Rick Rieder, BlackRock’s CIO for global fixed income. “If he doesn’t say anything, he will move the markets. If he says a lot, he will move the markets.”
Rieder said the briefing should be “exciting to see” and a challenge for the Fed to start changing communications about its policy. He said that investors will analyze every word. “This will be the March madness,” for the markets, he said, referring to the highly anticipated college basketball tournament.
Powell clearly has the ball, and what he decides to say on Wednesday will dictate tense markets when the Fed might consider reducing its bond purchases and even raising interest rates to zero.
Declaration to remain practically the same
The Federal Open Market Committee will release its statement at 2 pm ET on Wednesday after the meeting, and Fed observers expect little change in the text.
But the Fed also releases the authorities’ latest forecasts for the economy and interest rates. This could show that most authorities would be ready to raise the target rate for federal funds to zero by 2023, and some members may even be ready to raise rates next year.
“We think they will seem a little more optimistic, but still cautious. Having said that, we think it will be difficult for them to appear as peaceful as they have been just because the facts on the ground are improving,” said Mark Cabana, head of the Short Interest Strategy. of the USA at Bank of America. “As a result of that, we think they will sound a little less accommodating than the market expects. We believe they are likely to see a rise in late 2023.”
Rieder said the Fed has been constantly directing its easing programs, but now needs to start communicating that it hopes to change the policy on both asset purchases and interest rates. He said the Fed was explicit in saying that it would give ample time between the moment it starts communicating the change and the moment it takes action.
“It looks like it’s time,” he said. Rieder said his out-of-consensus view is that the Fed could start reducing bond purchases in September or December, and needs to start discussing that now. The Fed buys $ 80 billion a month in Treasury bills and $ 40 billion a month in mortgages.
He also said that the Fed could also start raising short-term interest rates next year, without hurting the economy. The Fed did not foresee any increase in interest rates until after 2023, but that could change in its latest forecast.
“They cannot raise short-term interest rates this year, but there is no reason, as you arrive in the second and third quarter of next year, that they can raise short-term interest rates that are inconsistent with your projections, ”said Rieder.
Rising rates
The Fed meets against a setback in rate volatility in the more typically sober Treasury market. In the past six weeks, 10-year yield, which influences rates on mortgages and other loans, rose from 1.07% to 1.64% last Friday. It was at 1.6% on Monday.
Yield, which moves against price, has responded to a more optimistic view of the economy, based on the launch of the vaccine and Washington’s stimulus spending. It also reacted to the idea that inflation may increase as the economy grows again. Powell said the Fed expects to see only a temporary jump in inflation measures in the spring, because of depressed prices during last year’s economic standstill.
“They need to start this communication … the markets are waiting for this,” said Rieder. “The rate hikes and market volatility are due to the fact that we have not yet heard their plan.”
Rieder said the Fed could raise interest rates while still buying bonds. He said he may want to target his purchases more for the long term to keep long-term rates low as they affect mortgages and other loans.
“In their economic projections, employment projections for the coming year are likely to be 4%. If you’re right, why not? Raising short-term interest rates and draining some liquidity from the front of the interest curve is no problem, “he said.
“Times like these require creativity and innovation,” said Rieder. “They were remarkably innovative. They provided a lot of liquidity to the system, the front end is flooded with liquidity and yields are very low, in an environment where you could have 7% growth this year.”
In the latest forecast, five of the 17 members expected a rate hike in 2023, and only one predicted a hike in 2022. Fed officials provide their rate forecasts anonymously, on a so-called dot chart.
The Fed said it would continue with bond purchases until it has made “substantial progress” towards its goals.
Cabana said there may be some officials who now expect an increase to 2022, but he does not expect the Fed to accept that yet. The federal funds futures market is pricing almost a high in 2022 and three highs by the end of 2023.
“Do you think that if the market is pricing this, and the Fed does not deliver, the market should be disappointed. In fact, we think that many in the market think the Fed will back down and the Fed will tell the market that it is wrong,” said Cabana . “We don’t think so. We think the Fed will maintain the option of having the market price in a more optimistic perspective. Does the Fed expect the market to be right, or are they right? The Fed expects the market to be right because it wants to achieve your goal earlier. We don’t think the Fed will pull back too hard. “
The Fed could say that “substantial progress is still far away,” said Cabana. He said he expects the Fed at some point to change the length of the bonds it is buying and to switch to the long end to prevent these rates, like the 10-year rate, from going too high.