Today’s FOMC meeting may be the most important one of the year. Fed members will decide on their next moves amid banking turmoil and high inflation, while Powell will try to calm the markets about the decision’s impact. There will be a number of topics on the agenda that might affect global markets.
Rate Path
The markets expect a 25 basis point hike with an 83.8% probability at the moment. Fed members hinted that they could go for 50, but the recent banking turmoil has completely changed the outlook. The Fed probably won’t want to put the fight against inflation in second place and will likely go for a 25 point hike. However, the key point won’t be this month’s move, but rather the future path.
The ‘dotplot’ at the December meeting showed that members expect rates to top 5.1%. However, just before the Silicon Valley Bank failed, there were hints of higher rates. Except for the ultra-hawkish members, we probably won’t see much change for 2023 in this meeting. But the main point is the difference between market pricing and Fed projections. The markets are now expecting rate cuts as soon as this summer and three rate cuts until the year’s end. Will the Fed repeat the saying, ‘the rates will stay high for some time’ or follow the ECB’s lead and say ‘the future path will be data dependent’ without clear forward guidance? The difference between these two options might move the market in today’s meeting.
Projections
The Fed will update its projections today, which will be a difficult task amid all the uncertainty. How will the latest developments in the banking sector affect GDP, PCE, and the rate path? Inflation expectations have significantly decreased in the last three weeks, with the 10-year breakeven falling to 2.24% from 2.51%. The University of Michigan’s short- and long-term inflation expectations also fell from 4.1% to 3.8% and from 2.9% to 2.8%, respectively. On the other hand, despite falling energy prices, service sector inflation is still rising due to a tight jobs market. How the changes in expectations and recent banking failures will affect the projections will be another market-moving factor today.
Balance Sheet and Liquidity
The Fed is continuing its balance sheet reduction operations, but last week these operations took a backseat. The Fed provided $165 billion in liquidity to banks amid the banking turmoil in just one week. This rush reversed almost three months of balance sheet reduction. The Fed will likely signal the continuation of the reduction operations, but there will be lots of questions for Powell in the press meeting about new liquidity moves, possible new tools, and the future of the balance sheet.
Conclusion
The Fed is on thin ice right now and probably wants to navigate carefully without making or committing to any drastic changes. A 25 basis point increase will be okay and won’t shock the markets, especially with a slightly more dovish press conference. Balance sheet operations will probably stay put, while the Fed commits to providing liquidity to banks if needed to calm the markets and the banking sector. As for the rate path, the Fed might want to follow the ECB’s lead and blur the forward guidance a bit due to the high uncertainty, but repeat the ‘rates will stay higher for some time’ speech to keep inflation expectations as low as possible.
