Federal Reserve Chairman Jerome Powell speaks at a House Select Subcommittee on the Coronavirus Crisis Hearing in Washington, D.C., USA, September 23, 2020.
Stefani Reynolds | Reuters
Chances are the Fed will move markets this week, no matter how hard it tries not to.
With interest rates soaring and the economy picking up, the Fed’s easy-going policies are in the spotlight, and the question is growing when it will consider phasing them out. Fed Chairman Jerome Powell is likely to be asked questions about the Fed’s low interest rate policy and asset purchases during his press conference following the Fed’s two-day meeting closing on Wednesday.
Powell is unlikely to be specific, but what he says could turn the already volatile bond market upside down, and that in turn could boost stocks. It could hit growth stocks especially if bond yields start to rise.
“I think the last press conference, I think I watched with one eye and listened with one ear. I’ll be tuning this one for every word, and the markets will be tuning for every word,” said Rick Rieder, BlackRock’s CIO for. global fixed income. “If he doesn’t say anything, it will move markets. If he says a lot, it will move markets.”
Rieder said the briefing should be “exciting to watch,” and a challenge for the Fed to potentially change the way it communicates about its policies. He said investors will parse every word. “This will be the March Madness,” he said for the markets, referring to the highly anticipated collegiate basketball tournament.
Powell clearly has the ball, and what he decides to say on Wednesday will dictate strained markets how soon the Fed could consider scaling back its bond purchases and even hike interest rates from zero.
Statement to remain largely the same
The Federal Open Market Committee will release its statement at 2 p.m. ET Wednesday, after the meeting, and Fed watchers expect little change in the text.
But the Fed also releases the latest government officials’ forecasts for the economy and interest rates. That could show that most officials would be willing to raise the Fed funds target rate from zero by 2023, and a few members may even be willing to hike rates next year.
“We think they will sound a bit more optimistic, but still cautious. That said, we think it will be difficult for them to sound as subdued as they have been just because the facts on the ground are improving,” said Mark Cabana, head of US short-term strategy at Bank of America. “As a result, we think they will sound a little less accommodating than the market expects. We think they are likely to show an increase by the end of 2023.”
Rieder said the Fed is steadily driving its easing programs, but must now begin to communicate that it expects to change policies for both asset purchases and interest rates. He said the Fed was explicit in the fact that it would provide enough time between when it starts communicating change and when it acts.
“I notice it’s time,” he said. Rieder said his view is out of consensus that the Fed could start tapering off bond buying in September or December, and it should start now. The Fed buys $ 80 billion in treasury bills and $ 40 billion in mortgages every month.
He also said the Fed could also start hitting short-term interest rates next year without hurting the economy. The Fed didn’t forecast rate hikes until after 2023, but that could change in its latest forecast.
“They cannot raise short-term interest rates this year, but there is no reason why they could raise short-term interest rates in the second and third quarters of next year that are inconsistent with their projections,” said Rieder.
Rates are rising
The Fed is facing a downturn in interest rate volatility in the more typically sedate treasury market. Over the past six weeks, the 10-year interest rate, which affects mortgage rates and other loans, has risen from 1.07% to a high of 1.64% last Friday. On Monday it was 1.6%.
The yield, moving against the price, has responded to a more optimistic view of the economy, based on the introduction of vaccines and Washington’s stimulus spending. It has also responded to the idea that inflation could pick up if the economy roars back. Powell has said the Fed expects inflation to rise only temporarily in the spring due to the low prices during last year’s economic shutdown.
“They have to start that communication … the markets are waiting for it,” said Rieder. “The volatility of interest rates and volatility in the market is because we haven’t heard their plan yet.”
Rieder said the Fed could raise interest rates while still buying bonds. He said it may want to shift its purchases more towards the long end to keep interest rates low over the longer term, as they affect mortgages and other loans.
“In their economic projections, their employment forecasts for next year are likely to be 4%. If that’s right, why not? Raising short-term interest rates and draining some liquidity from the front end of the yield curve isn’t a problem,” he said .
“Times like these call for creativity and innovation,” said Rieder. “They have been remarkably innovative. They have provided so much liquidity to the system, the front end is inundated with liquidity and the yields are too low, in an environment where you could have 7% growth this year.”
In the latest forecast, five of the 17 members expected an interest rate hike in 2023, and only one predicted an interest rate hike in 2022. Fed officials provide their interest rate forecasts anonymously, on a so-called dot chart.
The Fed has said it would continue its bond purchases until it makes “substantial progress” toward its goals.
Cabana said there may be a few officials now predicting a rise for 2022, but he doesn’t expect the Fed to embrace that yet. The Fed Funds futures market is pricing nearly one increase in 2022 and three increases by the end of 2023.
“You think if the market gives up and the Fed doesn’t deliver, the market should be disappointed. We actually think many in the market think the Fed will push back, and the Fed will tell the market it’s wrong. Cabana said. We think not. We think the Fed will retain the ability to keep the market price in a brighter outlook. Does the Fed hope the market is right, or are they right? The Fed hopes the market is right because it wants to achieve its goal sooner. We don’t think the Fed will back down too hard. “
The Fed could say “substantial progress is still some time away,” Cabana said. He said he expects at some point the Fed will change the maturity of the bonds it buys and shift to the long end to keep those interest rates, like the 10-year ones, from rising too much.