As the Federal Reserve gears up for its upcoming policy review, it appears that its primary message to investors and markets will echo the iconic British World War II slogan, "Keep Calm and Carry On."
Recent times have witnessed a scarcity of calm in financial markets, marked by aggressive market movements, particularly in 10-year Treasury yields. In mid-October, these yields behaved more akin to stock prices, surging to nearly 5% before sharply falling back to 4.24%. Against this backdrop, Wall Street economists are engaged in heated debates about the potential onset of a recession in the coming year, while derivative market traders anticipate the Fed to adopt an aggressive stance by cutting its benchmark interest rate by over 100 basis points. Strikingly, concerns about inflation and the federal government's ability to fund its substantial fiscal deficit seem to have dissipated.
The question now arises: will the Fed challenge these market expectations? According to Stephen Gallagher, the U.S. chief economist at Societe Generale, any pushback from the Fed is likely to be mild rather than forceful. The prevailing assumption is that the Fed will maintain its benchmark interest rate at 5.25%-5.5% after its December 12-13 meeting, marking the third consecutive meeting without a rate change. The last rate increase occurred in July.
The Fed's policy statement is expected to maintain a hawkish tone by discussing the potential for future tightening. The new "dot-plot" is anticipated to reveal only 50 basis points of cuts in 2024, consistent with the September forecast. While the new economic forecast may project slower economic growth in 2024, it will likely rule out a recession. During the press conference, Fed Chair Powell is expected to reiterate the possibility of future rate hikes if inflation accelerates, emphasizing that it is premature to discuss rate cuts.
Former Boston Fed President Eric Rosengren characterized the Fed as more of an "ocean liner" than a "speed boat," suggesting that the central bank is likely to make small changes rather than significant shifts.
Tom Porcelli, chief U.S. economist at PGIM Inc., anticipates that Fed officials might indicate three rate cuts in 2024. In response, Powell may adopt a slightly more hawkish stance during the press briefing to counterbalance this dovish sentiment. The fear is that sounding too dovish could potentially ease financial conditions and reignite inflation.
Despite the market's anticipation of rate cuts, Gallagher believes that it would require "jarring news" for the Fed to swiftly implement rate cuts. Agron Nicaj, U.S. economist at MUFG Bank, sees recent data indicating slower economic growth and subdued inflation as providing Powell with justification to adopt a slightly more dovish stance around the edges.
However, Gennadiy Goldberg, head of U.S. rates strategy at TD Securities, suggests that Powell's attempts to sound more hawkish might be challenging given the economic slowdown and the absence of projected rate hikes in the "dot-plot." Goldberg envisions a scenario similar to the November press conference, where the longer Powell spoke, the more dovish he sounded, emphasizing a tone of data dependence and "higher for longer."
In summary, as the Fed navigates the complexities of economic conditions, the tone it strikes during the upcoming review is expected to be one of caution, emphasizing the importance of data and signaling a nuanced approach rather than a swift policy shift.
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