Jerome Powell, president of the US Federal Reserve, speaks during a House Select subcommittee to hear the coronavirus crisis in Washington, DC, USA, September 23, 2020.
Stefani Reynolds | Reuters
Chances are high, the Fed will move markets this week, no matter how hard it tries not to.
With rising interest rates and a recovering economy, the Fed’s light-hearted policies are in the spotlight and the question is increasingly being asked when to consider them. Fed Chairman Jerome Powell may have questions about the Fed’s low interest rate policies and asset purchases during his press conference after the Fed’s two-day meeting on Wednesday.
Powell is different on specifics, but what he says could affect the already volatile bond market and, in turn, could lead to equities. It could particularly affect growth stocks 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 tuned to every word, and the markets will be tuned to every word,” said Rick Rieder, CIO BlackRock for global fixed income. “If he doesn’t say anything, he will move the markets. If he says a lot, he will move the markets.”
Rieder said the information should be “interesting to see” and a challenge for the Fed to start changing communications about its policy. He said investors will analyze every word. “This will be the Madness of March,” for the markets, he said, referring to the long-awaited collegiate basketball tournament.
Powell clearly has the ball, and what he decides to say on Wednesday will dictate to nervous markets how soon the Fed could consider stopping buying bonds and even raising interest rates from zero.
Statement to remain largely the same
The Federal Open Market Committee will release its statement at 2 p.m. ET on Wednesday after the meeting, and Fed observers expect small changes in the text.
But the Fed is also releasing officials’ latest forecasts for the economy and interest rates. This could show that most officials would be ready to raise the target rate of funds funded from scratch in 2023, and some members might even be ready to raise rates next year.
“We think they will look a little more optimistic, but still cautious. That being said, we think it will be hard for them to look as much evidence as they were just because the facts on the ground are improving,” said Mark Cabana, head of strategy. US short rate at Bank of America. “As a result, we think they will sound a little less accommodative than the market expects. We think they will probably show an increase at the end of 2023.”
Rieder said the Fed is constantly conducting its easing programs, but now it needs to start communicating that it expects to change its policy on both asset purchases and interest rates. He said the Fed was explicit in that it would provide a lot of time between when it starts communicating change and when it acts.
“It strikes me that it’s time,” he said. Rieder said his view outside the consensus is that the Fed could start reducing bond purchases in September or December and should start discussing this now. The Fed buys $ 80 billion a month in treasury and $ 40 billion a month in mortgages.
He also said the Fed could also start raising short-term interest rates next year without hurting the economy. The Fed did not forecast interest rate increases until after 2023, but that could change in its latest forecast.
“I can’t raise short interest rates this year, but there’s no reason why you end up in the second and third quarters of next year that could raise short-term interest rates that are inconsistent with their projections,” Rieder said.
Rising rates
The Fed is facing a declining rate of volatility in the more normal Treasury market. In the last six weeks, the 10-year yield, which influences mortgage rates and other loans, rose from 1.07% to a high of 1.64% last Friday. It was 1.6% on Monday.
Yields, which are moving at the opposite price, have reacted to a more optimistic view of the economy, based on the launch of the vaccine and Washington’s stimulus spending. He also reacted to the idea that inflation could rise as the economy roars. Powell said the Fed expects to see only a temporary rise in inflation measures in the spring due to depressed prices during last year’s economic shutdown.
“That communication needs to start … the markets are waiting for it,” Rieder said. “Jumping rates and volatility in the market are due to the fact that we have not yet heard their plan.”
Rieder said the Fed could raise interest rates while still buying bonds. He said he may want to focus his purchases more towards the long term to keep long-term rates lower as they affect mortgages and other loans.
“In their economic projections, their employment forecasts for next year are likely to be 4%. If correct, why not? Raising short-term interest rates and draining liquidity from the front of the yield curve is not a problem, ” he said.
“Times like this call for creativity and innovation,” Rieder said. “They were remarkably innovative. They provided so much liquidity to the system, the front end is full of liquidity, and the yields are too low, in an environment where you could have a 7% increase this year.”
In the latest forecast, five out of 17 members expected an rate hike in 2023 and only one is forecasting an increase in 2022. Fed officials provide their rate forecasts anonymously, on a so-called plot point.
The Fed has said it will continue to buy bonds until it makes “substantial progress” toward its targets.
Cabana said there may be some officials now forecasting an increase for 2022, but he does not expect the Fed to accept this yet. The futures fund market has prices close to an increase in 2022 and three increases by the end of 2023.
“Do you think that if the market appreciates this and the Fed doesn’t deliver, the market should be disappointed. In fact, we think many in the market believe that the Fed will push back and the Fed will tell the market that it is wrong,” Cabana said. “We don’t think so. We think the Fed will keep the option of having the market price in a more rosy perspective. 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 push back too hard. “
The Fed could say that “substantial progress is still on for some time,” Cabana said. He said he expects the Fed, at some point, to change the duration of the bonds it buys and move toward the long end to keep these rates, such as those for 10 years, from rising too high.