Federal Reserve policymakers are widely expected to increase interest rates by another three-quarters of a point Wednesday, and they may surprise markets by sounding even more unrelenting in their tightening efforts.
To put it another way, the Fed would appear to be “hawkish,” or determined to raise interest rates as high as necessary in order to reduce inflation. At 2 p.m. ET on Wednesday, the central bank is anticipated to make the rate announcement. At 2:30 p.m. ET, Fed Chairman Jerome Powell then addresses the media.
Increasing the fed funds rate by 75 basis points would set the rate somewhere between 2.25% and 2.5%. The fed funds rate range was zero to 0.25 percent when the Fed started raising interest rates in March.
Investors will be eager to hear Powell’s thoughts on the Fed’s potential actions at its meeting in September. This month, markets were even bracing for a full-point rise, but Fed officials discouraged those expectations.
“I do think they’re going to lean a little bit more hawkish on September,” Jim Caron, head of global fixed income macro strategies at Morgan Stanley Investment Management, stated. “They’re just not seeing the progress on inflation.”
The Federal Reserve may offer a new insight into the condition of the economy, which many economists consider is slowing.
“There’s going to be a lot of two-handed economist talk from Jay Powell,” stated Vincent Reinhart, Dreyfus and Mellon’s top economist. “He’s going to say we’re definitely going through a soft inventory and trade cycle.”
Reinhart says that Powell should recognize that economic growth has slowed, but Powell might also state that there is a fundamental, solid support for the economy. Despite the rise in jobless claims, the labor market continues to be strong.
“I think it’s going to be a mixed bag. He’s going to be talking ahead of what could be another quarter of real GDP decline,” Reinhart said.
On the eve of Thursday’s release of second-quarter gross domestic product, some economists expect the government to show a contraction. Which implies that the economy could be heading for recession. For example, there are those who say it is in one because the GDP numbers are so bleak.
As per Reinhart, the National Bureau of Economic Research, however, uses other criteria to determine when to declare a recession, and it is not expected to do so yet.
Still, some traders think the Fed’s aggressive policy tightening will ultimately lead to a recession. The Fed’s rate hike trajectory is expected to be reinforced by Powell, which may seem hawkish.
“He could talk about the cycle going well into next year,” Michael Schumacher, director of rates strategy at Wells Fargo, said. “The market is pricing a pretty quick end to the hiking cycle. That’s just not realistic. I think he’ll sound pretty hawkish.”
The market expects a complete change in Federal Reserve policy for next year. The Fed is expected to begin cutting rates by spring next year once the fed funds rate reaches 3.4 percent by the end of this year.
At this point, it looks like high inflation is what’s driving the central bank to raise rates. In June of this year, the Consumer Price Index rose 9.1%, the highest inflation since November 1981.
“We have yet to see sequential core CPI falling,” said Caron. “To me, if this is a major threshold for them then they’re going to continue to be aggressive. They could communicate that. That would sound hawkish.”
Core CPI, excluding energy and food, rose 0.7% in June, which was 0.6% as of May.
According to Caron, a hawkish Fed might lead to higher short-term Treasury yields and a post-meeting decline in stock prices. The yield curve will invert even more if longer-term yields, such as those on the 10-year Treasury note, continue to decline due to recessionary fears.
If the 2-year Treasury yield is higher than longer term yields, the yield curve is inverted and is often regarded as a recession warning. Monday’s yield on the 2-year, which generally reflects Fed policy, was about 20 basis points higher than the 10-year.
“Major problem: inflation is not coming down,” said Caron. “They’re not going to really tell you this but that’s the problem.” He also stated that the Fed will not be discouraged by declining asset prices as interest rates climb.
“They can’t say they’re making progress on inflation. They can’t say they even have one month in a row of success,” Caron said. “They’ll probably say policy interest rates are helping slow the economy. It works with a lag.”
According to Diane Swonk, chief economist at KPMG, Powell’s task will be more harder because the Fed has divided opinion on whether to rise more or less.
“There’s still going to be debate within the Fed. You have suddenly a lot of voices. This is the first time they’re fully staffed, and you have more Fed presidents,” she said. “There’s the debate of whether they go faster or slower now. The messaging gets more complicated for Powell, given the diversity of views.”
Powell may also choose to speak more ambiguously than he did at the last meeting and may not lay his cards on the table when it comes to the idea of quitting in September.
“At the past few meetings Chair Powell has signaled (or mis-signaled) the expected size of the rate move at the subsequent meeting. We don’t expect him to be so definitive,” Michael Feroli, the head economist at JPMorgan, said. “While he will almost certainly indicate that the committee expects to continue tightening policy, with two jobs reports between now and the September meeting, we don’t see the upside to putting a stake in the ground in late July. Powell will very likely get asked about the chance of recession; we suspect he will say it’s a risk but not a foregone conclusion.”