Call it a sign of the times when a half-percentage-point rate hike will be viewed by the Federal Reserve as looser monetary policy.
Prior to this year, the Fed had not increased benchmark lending rates by more than a quarter point at a time in 22 years. In 2022, they’ve made it five times – four times for a three-quarter point and once for a half a percentage point – with Wednesday’s much-anticipated 0.5 percentage point move set to be the sixth.
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A bitter struggle against inflation has turned political norms upside down. Investors have now grown accustomed to an aggressive central bank, so any move lower will be viewed as relative easing by recent jumbo moves.
Wednesday’s rate-setting Federal Open Market Committee meeting will bring a number of moves to chew on. It is about the current interest rate hike as well as what the Fed is planning and where it sees the economy going.
Here’s a quick look at the different variables that go into the result:
Especially given Tuesday’s weaker-than-expected CPI inflation report, it would be a shock if the FOMC did anything but hike the fed funds rate by half a notch and bring the overnight benchmark to a target range of 4.25%. 4.5%, the highest level in 15 years.
While the committee vote is likely to be unanimous or close, not everyone is on board.
“I hope Jay Powell will stand his ground and continue to do what needs to be done,” said former FDIC Chairman William Isaac. “I hope they go up at least a point.”
Then there is the other side.
“This walking cycle should be over by now,” wrote Tom Porcelli, US chief economist at RBC Capital Markets. “We’ve liked to say for the past few months that the Fed is fighting yesterday’s war on inflation. … There is no need to raise interest rates any further at this point, but of course it will.”
Behind this unanimous or near unanimous vote on interest rates will be a heated debate on how monetary policy should proceed from here.
This should be reflected in both the post-meeting statement and Powell’s press conference.
One area where markets are looking for change is the wording that the FOMC “considers continued increases in target range will be appropriate” or something more general like “some increases” might be needed. That gives the Fed flexibility for its next move, with some in the market anticipating that February could be the last rate hike for a while. The Fed’s next interest rate decision after this one is due on February 1st.
Powell is being examined to provide clarity on where the committee sees the future of its inflation fight. He will likely reiterate that the Fed will hike rates and keep them high until inflation shows concrete signs of returning to the central bank’s 2% target.
“Traders will be watching Jay Powell’s Q&A closely as we seek guidance for February, which may only be a 25th month [basis point] and what the FOMC’s plan is to achieve an even higher terminal rate over an extended period of time,” said Victor Masotti, director of repo trading at Clear Street.
The committee will also update its inflation, unemployment and GDP forecasts. Inflation and GDP forecasts for next year could fall and unemployment could rise a bit higher.
The “dot plot” and the “final rate”
This “end rate” that Masotti spoke of points to the expected end point for the Fed and its current rate hike cycle.
When the Fed last updated its dotplot – a chart that gives each FOMC member an anonymous “dot” to forecast interest rate movements over the next few years – the final interest rate was fixed at 4.6%.
As inflation continues to rise despite the latest reports, the end point is also likely to rise. But maybe not as strong as the market feared.
Goldman Sachs said it was “a narrow chance between 5-5.25% and a smaller rise to 4.75-5%. We continue to expect three increases of 25 basis points in 2023. [Tuesday’s CPI] Report reduces risk of 50bp hike in February.”
Signaling a softer approach could be dangerous, said Isaac, who was FDIC chairman in the early 1980s when inflation was raging and then-Fed Chairman Paul Volcker had to hike rates sharply and plunge the economy into recession.
“People need to have faith in the Fed, and that’s what Volcker brought. They knew he meant what he said,” said Isaac, chairman of Secura/Isaac Group, a global consulting firm. “If you don’t have confidence in the government and especially the Fed, it’s going to be a long, hard hit.”
Finally, at 2:30 p.m. ET, Powell will take the stage for approximately 45 minutes to answer press questions.
In recent meetings, the chairman has used the session to bolster the Fed’s anti-inflation credentials and promises to raise rates until prices are firmly back on solid ground.
The market didn’t always believe him.
Even at times when Powell has used harsh rhetoric, traders — and the electronic algorithms that tend to cause short-term market shocks — have chosen to focus on the cautious qualifiers and propel stocks higher. After a string of relatively upbeat inflation reports, Powell may need to apply a little more pressure this time around.
“He should spare us the over-the-top hawk antics,” RBC’s Porcelli said. “Say you’re not done and there’s more to do etc. And leave it at that. He may not like the easing in financial conditions lately, but the markets have eyes.”
Correction: In 2022, the Fed raised interest rates five times by more than a quarter point. An earlier version mistyped the number.