Federal Reserve Chairman Jerome Powell speaks during the Centennial Conference of the Division of Research and Statistics of the Board of Governors of the Federal Reserve System on November 8, 2023 in Washington DC, USA. (Photo by Celal Gunes /Anadolu via Getty Images)
Celel Gunes | Anadolu | Getty Images
This week's Federal Reserve meeting is expected to mark a major turning point for policymakers who have battled runaway inflation over the past two years.
That there is virtually no chance that central bank policymakers will vote to raise interest rates is beside the point: When the Federal Reserve's Federal Open Market Committee meeting ends on Wednesday, there will likely be a policy shift away from aggressive rate hikes and toward plans for the next steps come.
“This would be the third straight meeting where the Fed remained on hold and, in our view, means the Fed likely sees the rate hike cycle complete,” Michael Gapen, U.S. economist at Bank of America, said in a note to clients .
While Gapen acknowledges that future inflation accelerations could force the Fed to raise interest rates further, “we believe that a slowdown in the economy is more likely and that the narrative should shift toward cuts rather than rate hikes in 2024,” Gapen added .
This move to cut rates, although likely expressed in subtle ways, would mark a major turning point for the Fed after 11 rate hikes.
In addition to an interest rate announcement, the Fed will also update its forecasts for economic growth, inflation and unemployment. Chairman Jerome Powell will also hold his usual post-meeting press conference, where he could either discuss a strategy to ease monetary policy now that inflation is slowing, or he could continue to speak tough, an outcome that the could shake markets.
Here's a quick overview of what to expect:
The statement
In its post-meeting communique, the Federal Open Market Committee, which sets interest rates, will almost certainly say it is keeping its benchmark federal funds rate in a range between 5.25% and 5.5%.
There could also be some language changes in the committee's assessment of employment, inflation, housing and general economic growth.
For example, Bank of America believes the committee could drop its reference to “additional monetary tightening” and simply say it is committed to bringing inflation back to 2%.
Likewise, Goldman Sachs sees the possibility that the statement excludes a description of tighter financing conditions and may make some other small changes that were used to convey a bias towards interest rate hikes.
Financial conditions, a matrix of economic variables and stock market prices, have eased significantly since the Fed's last meeting on Nov. 1.
“A pause is all but guaranteed,” said Liz Ann Sonders, chief investment strategist at Charles Schwab. “But I wouldn't be surprised if there was a little resistance, if not in the statement then during the press conference, to easing financial conditions. … Powell needs to deal with this.”
The dot chart
If there is any hint of looming interest rate cuts, it will happen in the closely watched grid of expectations of individual Fed members known as the dot plot. Markets pay attention to the “median point,” or midpoint, of all members’ forecasts for the next three years and longer term.
An immediate change to the chart will be the removal of a previously announced rate hike this year.
Furthermore, market prices are aggressive. According to calculations by CME Group, traders in Fed funds futures expect interest rate cuts to begin in May 2024 and continue until the Fed has cut at least a full percentage point from the key interest rate before the end of the year.
“This is going to be very important because a lot of the rise in stocks is due to a dovish move with interest rate cuts coming,” said Quincy Krosby, chief global strategist at LPL Financial. “If they go down and match the market even a little bit, the market will go higher and higher.”
However, most Wall Street strategists and economists see a more cautious approach. Goldman Sachs, for example, has brought forward its expectation for the first cut, but only to the third quarter of next year, which is well above market prices.
“A lot would have to happen for it to happen so quickly,” Goldman chief economist Jan Hatzius recently said on CNBC. “The second half of the year is more realistic than the first.”
“I'm not saying it won't happen, I just think it's premature based on current data collection,” Schwab's Sonders added. “At the end of the day, the bond market may be right [about rate cuts]but probably not without economic problems until March.”
The economic prospects
Each quarter, FOMC members also release their forecasts for key economic variables: gross domestic product, inflation, as measured by the Commerce Department's core personal consumption expenditures price index, and unemployment.
In September, the committee pointed to a slowdown in GDP growth, a slight increase in unemployment and a gradual return of inflation to the Fed's target by 2026.
These numbers shouldn't change much. Goldman expects “a small upward revision” in GDP and slight downward forecasts for unemployment and core PCE inflation.
There probably isn't much to see here.
The press conference
Then Chairman Powell will take the stage, and an otherwise little-known event could turn into something much more interesting.
Powell has a line in front of him – he is aware that he will continue the fight until inflation is defeated, and at the same time he is aware that real interest rates, or the difference between the key interest rate and inflation, are rising as the latter gradually increases Slowdown continues.
The target interest rate is currently between 5.25% and 5.5%, more precisely 5.33%. Although Tuesday's consumer price index report showed that inflation excluding food and energy was 4% annually in November, core PCE inflation is 3.5%, a real rate of about 1.8%.
In normal times, Fed officials see the so-called neutral interest rate — neither restrictive nor stimulative — closer to 0.5%. Hence Powell's recent statement that interest rates are “well in restrictive territory.”
“We expect that FOMC leadership views rapid disinflation as a reason that the nominal federal funds rate may need to be lower at some point in 2024, for no other reason than maintaining the same level of real tightening,” says UBS economist Jonathan Pingle said in a note. “However, we do not expect Chairman Powell to signal anything soon.”