What will be the message from the FOMC on Wednesday
The FOMC decision is Wednesday at 1800 GMT (2 pm ET) and will include a statement along with new quarterly forecasts and a press conference from Chairman Jerome Powell 30 minutes later.
The main theme to watch is whether the Fed introduces some kind of tightening bias with many market-watchers leaning in that direction in recent days. I don't think that's going to happen, but here are the things to watch.
1) The dot plot
These are the first new projections since Dec 16 and there has been a lot of fiscal stimulus since then and the economy handled the winter covid surge much better than anticipated.
As you can see, virtually all FOMC members predicted no rate hikes through 2024 in those dots. Just four of 17 saw hikes with one (ahem Bullard) making the hero call of four hikes by then. One of the main headlines around the FOMC will be whether the majority of dots move into 2023. That would mean at least 9 dots out of 17. Goldman Sachs economists think it will be 11.
This is likely to be the main market-moving headline on the release of the statement and forecasts.
The market is pricing in three hikes by the end of 2023, so there's a big disconnect here but even no dots move at all, that divergence isn't going to close. The Fed's credibility is going to be put to the test (more on that later).
Finally, we also get 2024 dots this month so that will add much more colour to the path they see, with the consensus expecting to see three quarter-point hikes at the median.
It looks like 2020 was about -3.5%, which is worse than the FOMC projection but the consensus on 2021 is now 5.6% followed by 3.9% next year. With the new stimulus I believe the market sees +6% growth. The Fed will definitely move in that direction.
The more-important number is going to be on core PCE inflation. Does that move up? Or is that reflexive to where policymakers put their dots. What if the dots stay pinned by 2023 shows 2.4%? Would that be a strong signal about the Fed's willingness/want to overshoot?
Problems in the repo market this month have led to all kinds of talk about an SLR extension. That's cooled as that market's recovered on the 10y sale that settled Monday. I believe the Fed would have signaled an extension if it was going to come and they haven't.
That leaves some scope for disappointment but I'd be wary of going with the initial bond market move. I suspect the Fed has a pretty good grasp on the risks around the SLR so I would fade any significant move on it.
4) Powell's press conference
The contrast in the market now and two weeks ago is stark. There was so much pressure on the Fed to talk down rates but now that's disappeared in stimulus euphoria and with yields flattening out.
Essentially, Powell stared down the market and won. It was impressive.
Now the market is running in the other direction and saying he will hint a taper or some more-optimistic path on rates.
I can see the thinking: Markets are healthy and a huge stimulus just passed but I don't think it's coming. Powell knows that if he shifts, we could get rates back up to 2.0% on the 10-year and then he would have to backtrack as the dollar surges.
The messaging has been clear and centered around unemployment. He's going to emphasize that unemployment would still be near 10% if discouraged workers were factored in. I expect him to be dovish but one little slip-up and that the market could run in the other direction.
5) The overall strategy
US 10-year breakevens hit 2.3% today. That's a sign that markets expect the Fed to achieve its aim. Mission accomplished, right?
Chicago Fed President Charles Evans has outlined the problem with that thinking. If the Fed sees that and then suddenly shifts towards a hike bias, it reinforces that 2% is really a ceiling, not a two-sided target.
In order to get credibility around a 2% target, then need to prove they can let it run hot before acting. They don't want to be ahead of the curve and don't even want to be 'on' the curve, they want to be slightly behind it.
Moreover, the market is trying to sniff out a path for an eventual taper. Here's how Goldman Sachs lays it out: