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Today’s Federal Reserve meeting is set to be one of the most interesting in quite some time. Investors are looking for more information around the Fed’s plans to start tapering monthly Treasury and mortgage-backed securities purchases, and the board will release its updated dot-plot of quarterly economic and interest-rate projections out to 2024.
All of this comes as markets are reeling amid concerns over the potential failure of Chinese property giant Evergrande Group—not to mention slowing growth, rising inflation, a stalemate in Washington over the debt ceiling, and the resurgent pandemic. Fed Chairman Jerome Powell in his postmeeting press conference will look to assure investors that the central bank is aware of growing risks and isn’t thinking about lifting interest rates while potentially having to acknowledge higher inflation forecasts and a more hawkish dot plot.
Here is what to expect when the Federal Open Market Committee’s statement and the summary of economic projections are released Wednesday at 2 p.m. Eastern time, followed by Powell’s press conference at 2:30.
Taper Timing
Wall Street expects the FOMC to in November formally lay out plans to start tapering its $120 billion in monthly bond purchases. That means investors should prepare for a signal Wednesday that the official announcement is coming after the next meeting Nov. 2-3.
Aneta Markowska, chief economist at Jefferies, says she expects the FOMC to open the door to a possible November taper announcement, conditional on a solid September employment gain. Markowska pegs that September nonfarm payrolls increase at about 750,000—which she thinks should be cleared “fairly easily.” As there is only one jobs report between now and the November meeting, economists say a decision to start reducing purchases in November will depend on the September payrolls report. Another miss, Markowska says, and the Fed could push the decision until December.
Any development on tapering plans may show up in two places. Markowska expects the FOMC’s statement to reiterate Powell’s August Jackson Hole speech, where he said the “substantial further progress” test has been met for inflation and where “clear progress” has been made toward maximum employment. (In Fed speak, “clear progress” isn’t quite “substantial further progress.)
More specifically, economists at Goldman Sachs expect the updated statement to say something like, “The Committee expects to begin reducing the pace of its asset purchases relatively soon, provided that the economy evolves broadly as anticipated.”
Others expect less formality. Kathy Bostjancic, economist at Oxford Economics, sees Powell more signaling during his press conference that tapering is on track to start in November. That, she says, is a clearer avenue to provide further guidance compared with in the policy statement.
New Economic Forecasts
Economists say investors have largely already priced in tapering. More interesting, says Markowska, is the new Summary of Economic Projections. For the first time, policy makers will submit forecasts for 2024.
Here’s where there is a chance for a hawkish surprise. The Fed has to upgrade its inflation forecast for this year significantly given persistently hot readings. Even if Fed officials assume 0.1% month-over-month increases between now and the end of the year, the Fed’s favored inflation gauge would average 3.5% year-over-year in the fourth quarter, Markowska says. She notes that’s up from 3% in June, and it is well above the Fed’s longstanding 2% target.
The question is whether an upwardly revised inflation forecast for this year affects members’ 2022 and 2023 inflation projections. Markowska sees a good chance that those forecasts are also revised higher, given persistent wage pressures and rising inflation expectations. Higher inflation forecasts beyond 2021 would undermine the notion of “transitory” inflation.
Meanwhile, growth forecasts need to be revised lower. Economists at Goldman say their 2021 GDP forecast has dropped over 2 percentage points on a Q4/Q4 basis since June, and they similarly expect the FOMC to cut its 2021 projection substantially.
Connecting the Dots
The updated dot plot is another place ripe for a hawkish surprise. It would only take two members to lift their dots from “no change” for half of the FOMC to expect at least one rate increase in 2022, says Bostjancic at Oxford Economics. She is looking for the median interest-rate forecasts to reveal earlier and faster-than-expected tightening of monetary policy, though her base-case is for two 0.25% increases in 2023. The Fed has so far suggested interest rates won’t rise before 2024.
Markowska, for her part, sees less than a 50/50 chance that the FOMC’s updated dot plot suggests rates will lift off in 2022. First, any participant lifting their 2022 dot must also upgrade their labor market outlook, for which Markowska says there is little justification. Second, Markowska says there is only one obvious dot—Boston Fed President Eric Rosengren’s—that is likely to shift. The other dots in play, she says, include those of governor Michelle Bowman, governor Randal Quarles, and Richmond Fed President Thomas Barkin.
The bond market is pricing in a near 70% chance of one rate hike in 2022 and a cumulative 75 basis points of tightening by the end of 2023. If bonds are right and two members push their dots up to signal 2022 liftoff, Powell will be in an awkward position. Powell’s promise that tapering doesn’t start the clock on tightening, as has been the case in the past, has helped investors shrug off tapering.
“Such an outcome would present a communication challenge for Chair Powell as he tries to decouple the timing of tapering from the timing of rate liftoff,” says Bostjancic.
Write to Lisa Beilfuss at lisa.beilfuss@barrons.com
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