All Eyes On Fed

Inflation is stubbornly above target, the economy is growing at about a 3% pace and the labor market is holding strong. Put it all together and it sounds like a perfect recipe for the Federal Reserve to raise interest rates or at least to stay put.

That’s not what is likely to happen, however, when the Federal Open Market Committee, the central bank’s rate-setting entity, announces its policy decision Wednesday.

Instead, futures market traders are pricing in a near certainty that the FOMC will actually lower its benchmark overnight borrowing rate by a quarter percentage point, or 25 basis points. That would take it down to a target range of 4.25% to 4.5%.

If the Fed follows through on the cut, it will mark a full percentage point lopped off the federal funds rate since September.

While that is a considerable amount of easing in a short period of time, Fed officials have tools at their disposal to let the markets know that future cuts will not come so easily.

One of those tools is the dot-plot matrix of individual members’ expectations for rates over the next few years. That will be updated Wednesday along with the rest of the Summary of Economic Projections that will include informal outlooks for inflation, unemployment and gross domestic product.

Another tool is the use of guidance in the postmeeting statement to indicate where the committee sees policy headed. Finally, Powell can use his news conference to provide further clues.

It is the Powell parley with the media that markets will be watching most closely, followed by the dot plot. Powell recently said the Fed “can afford to be a little more cautious” about how quickly it eases amid what he characterized as a “strong” economy.

Powell is almost certain to be asked about how policy might position in regard to fiscal policy under President-elect Donald Trump.

Thus far, the chair and his colleagues have brushed aside questions about the effect Trump’s initiatives could have on monetary policy, citing uncertainty over what is just talk now and what will become reality later. Some economists think the incoming president’s plans for aggressive tariffs, tax cuts and mass deportations could aggravate inflation even more.

More here