What Will The Fed Do Today: The Complete FOMC Preview
The US Federal Reserve meets. Today is all about expectations, including the fabled dot plot of FOMC member forecasts. Former Fed Chair Greenspan once declared “I know you think you understand what you thought I said, but I’m not sure you realize that what you heard is not what I meant.” Greenspan is no longer Fed chair, and so the dot plot was invented to replace that confusion.
– UBS chief economist Paul Donovan
As previewed yesterday, today is all about the conclusion of the 2-day FOMC and Powell’s subsequent press conference with this meeting also including the latest economic projections and dot plot from the FOMC’s members (the first one since the end of 2020). DB’s Jim Reid reminds us that back in December when the last dot plot was released, it showed that most of the committee favored keeping rates on hold at least through to the end of 2023. But since then we’ve seen a sharp move higher in Treasury yields thanks to the passage of the $1.9tn stimulus package, and markets are now pricing in an initial hike from the Fed within the next 2 years and three hikes in total by the end of 2023.
With a more robust outlook ahead, DB’s US economists expect that one hike should be reflected in the committee’s updated projections out to end 2023 (via the median dot) but it’s a close call. However higher growth and lower unemployment will be in the forecasts, as well as a modestly higher inflation trajectory.
As a reminder, Goldman also expects the Fed to unveil 2023 liftoff, with 11 participants showing at least one hike in 2023 versus 7 showing no hikes (Christopher Waller has joined the Board of Governors, raising the number of submissions to 18). Of those showing at least one hike, most will show just one, but a handful will show two or more, in line with market expectations of 3 rate hikes. For more on market’s reaction to the median 2023 dot, please read “All Hell Could Break Loose”: The Fate Of The Market Is In The Median 2023 Dot.
The press conference may bring most of the focus though with every word scrutinized and cross examined given the recent run up in yields.
Some curious facts from Deutsche Bank: Powell has now presided over 24 FOMCs and on average the S&P 500 has been -0.15% (15 out of the 24 were down days) lower on decision day – though this is heavily weighted by his first 7 meetings, which saw equities slip back when the Fed started its small hiking cycle in 2018. In terms of 10 year yields they have been -3.0bps lower on average with a median of -1.6bps (16 out 24 down in yield) on Powell FOMC days. To put this in perspective the S&P 500 is up +49.5% since his tenure begun in February 2018 and 10yr yields are down -108.8bps.
With that in mind, here is a comprehensive preview courtesy of Newsquawk of everything that Wall Street expects Powell to cover (or ignore) in today’s closely watched FOMC rate decision at 2pm and Powell press conference at 230pm ET:
- The Fed will keep the Federal Funds Rate target at 0-0.25%, and the rate of its asset purchases steady at USD 120bln per month.
- Updated economic projections will reveal the extent to which officials see the brighter growth outlook translating into rate hikes down the line; previously it had not pencilled in any hikes through the end of 2023.
- Analysts will also be paying attention to the extent the Fed forecasts an overshoot of inflation, in keeping with its new policy framework.
- The Fed may update on whether SLR relief for banks will continue beyond March, although since it does not strictly relate to monetary policy, it may ignore the issue.
- Traders will also be looking out for any hints about the conditions the Fed wants to see before scaling-back asset purchases. Judging by recent commentary from senior officials, Chair Powell will likely adopt a stoic approach to the bond market sell-off, reiterating familiar arguments, and he may again avoid jawboning rates lower with threats of twisting purchases or yield curve targeting policies.
- A hike to the IOER rate is a possibility, but this would be framed as a technical adjustment rather than a change in monetary policy course.
HIKE TRAJECTORY: Focus will be on the 2022 and 2023 dots to judge how far the improvement in the economic outlook translates into higher rates in the Committee’s view. Currently, market-based pricing assesses that there is a risk of a rate hike in 2022, and has fully priced a rate rise in 2023, which contrasts with the Fed’s December projections, where the median forecast saw rates remaining unchanged at current levels (0-0.25%) over its forecast horizon through end-2023; in December, just one of 17 FOMC participants had envisaged a 2022 rate hike, while just five saw rates above current levels in 2023. There is still a chance the median forecast will not envisage a hike, however, despite the Fed being likely to upgrade its growth view. Barclays’ analysts reason that the Fed is likely to see the economy as in a similar fundamental position at the end of 2023 as it did last December; fiscal stimulus will likely push GDP growth higher in the short-term relative to what the FOMC was forecasting last year, but Barclays argues that subsequent growth rates will be slower as federal expenditures retrace, leaving economic fundamentals on a broadly similar footing at the end of the forecast horizon vis-á-vis the Fed’s prior outlook.
INFLATION COMMITMENT: The Fed aims to achieve inflation “moderately above 2% for some time” so that inflation “averages 2% over time and longer-term inflation expectations remain well anchored at 2%”; the key question is how the Fed sees the Q2 2021 inflation spike contributing to the ‘average’ profile of inflation, and does the expected surge in inflation this year imply less of a need to overshoot later in the cycle? The updated economic projections may reveal what level inflation will be at when the Fed envisages its next hike; for reference, the median of dealers surveyed by the NY Fed in January estimated that headline PCE would be running at 2.2% when the Fed fires its first hike.
QE TIMELINE: Fed officials have stated that the current pace of bond purchases remains appropriate, and rates would not be hiked while the Fed is making these purchases, which implies the timing for QE is pivotal to the timing of future rate hikes. However, officials have also been clear that its guidance is outcome-based, which makes it trickier for market participants to price rate hikes in money markets; Goldman Sachs thinks that without any date-based guidance on QE, front-end rates may need to reprice higher. Powell and Co. have generally been cautious about attaching any date-based guidance to its policy, but have suggested that the pace of QE remains appropriate for now, and can be expected to continue through the end of this year at least. However, considering the more optimistic view about the medium-term, market participants will be keeping an ear out for any conditions the Fed wants to see before it begins pulling back purchases from the current USD 120bln/month pace; analysts at Societe Generale think it would be premature for the central bank to offer specifics given it wants to maintain as much policy flexibility as possible.
PUSH-BACK ON RISING RATES: Officials at the ECB have been far more aggressive in pushing-back against higher EGB yields, last week opting to adjust asset purchases (front loading) to reinforce officials’ verbal interventions. The Fed has been reticent to do so, and instead key officials have attributed the recent rise in yields to optimism in the recovery narrative, while others have noted the USD 1.9trln fiscal stimulus package amid an environment where all Americans will likely have access to vaccinations by May. The Fed will have noted that 10-year breakevens last week rose to the highest levels since 2014, and crucially, the rise in inflation expectations was not accompanied by a similar rise in real yields, which analysts at BMO say may provide Fed officials with encouragement. One of the key standouts over the last three weeks has been the Fed’s stoic approach to turmoil in the bond markets, and that approach has been vindicated. This suggests that the statement and the position of Fed Chair Powell will be consistent with recent commentary, suggesting that Powell will steer clear of any detailed discussion of extending the weighted average maturity of Fed purchases further out the curve, and any yield curve targeting policies, although he may remind us that both tools remain in the Fed’s toolbox for use if necessary, while the Fed also has the option to ‘twist’ asset purchases if needed (offsetting short-end sales with long-end purchases). Powell will likely reiterate that while the near-term is mired by uncertainty, the outlook for the second half is brighter, asset purchases at the current rate remains appropriate for this year at least, it will take a great deal of time for inflation to moderately exceed the Fed’s target sustained basis, perhaps three years; there is still a huge amount of progress needed in the labour market.
SLR: Banks’ supplementary leverage ratio requirement (SLR) is a capital rule that requires institutions to hold a certain percentage of capital against total assets. In April 2020, regulators exempted Treasuries and deposit reserves from banks’ SLR calculations, which allowed these banks to build balance sheets by purchasing Treasuries without hindering their SLRs (some analysis suggests USD 300bln of Treasuries were accumulated over the last year). This arrangement is set to expire at the end of March, and if it were not extended, banks could have to hold more capital against their holdings of Treasuries if SLRs suddenly become the binding capital constraint on banks, which some warn may result in reduced demand for government debt, perhaps triggering in a wave of Treasury selling, which could in-turn reduce funding for other Treasury investors, stoke volatility in fixed income markets, and potentially result in significant market disfunction. Some think that the recent sharp decline in dealers’ holdings of Treasuries could be a function of concerns that SLR relief will not be extended, with banks preparing for the possibility that an extension decision does not come.
Goldman Sachs dismisses these concerns, noting that the recent decline in dealer holdings was driven by a fall in holdings of Treasury Bills; GS also says that many banks have SLR exemptions at the parent company level, where it is a default exemption, not at the subsidiary level, where banks have to opt-in, which it sees as a sign of confidence that there may not be any forced Treasury selling if the relief was not extended. Other analysts have expressed forward-looking concerns regarding the evolution of bank balance sheets as Treasury issuance continues to balloon and the Fed continues to flood the system with reserves via QE; SLR may not be an issue now, but soon could become the binding restraint.
NOTE: any decision on SLR relief is taken at the Fed board-level, and in conjunction with the FDIC and OCC – it is not made at the FOMC-level, which suggests there is some scope for the issue to not feature heavily at this week’s FOMC. Given the issue relates to bank regulation rather than the implementation of monetary policy, it is possible that the FOMC could ignore the issue, although many expect Powell to be pressed on the issue in the Q&A. If the Fed did choose to act, it could do so by either extending the relief, ending it, or perhaps just extending relief for holdings of deposits (reserves), rather than Treasuries.
POSSIBLE IOER HIKE: Intricately linked to the SLR theme is whether the Fed will ‘technically’ lift the rate of Interest on Excess Reserves, the idle cash that banks hold in excess of regulatory requirements which are then parked at the Fed. In recent weeks, the Secured Overnight Financing Rate (SOFR, the Libor-replacement) has been flirting with negative territory as an excess amount of cash chases a limited amount of collateral. It is important to note that the SOFR is not a Fed policy rate, although it can influence other STIRs as well as the Effective Federal Funds Rate, and Dutch bank ING argues that if it were to fall to zero or turn negative, it might suggest that the Fed has lost some control over the front-end of the curve at a time when the economy is picking-up. The situation might be helped if the pace of Treasury issuance picks up, but that is something that will take months and quarters rather than weeks; if the Fed wanted to act now, ING says it could hike the IOER to lift other liquidity buckets. Some desks look for a hike of between 5-10bps from the current 10bps.
FIRST LIFTOFF, I.E. THE 2023 MEDIAN DOT: Goldman writes that after its latest forecast upgrades, the bank views the first hike in the funds rate as a close call between the second half of 2023 and the first half of 2024. The working assumption has been that the FOMC’s inflation threshold for liftoff is 2.1%, and Goldman now expects to reach this slightly earlier in 2023 H2, which would argue for bringing forward the timing of liftoff from the standing forecast of 2024 H1.However, Goldman admits that it is “increasingly unsure where FOMC participants put this threshold and see the risks as tilted to the higher side, for two reasons.” First, the New York Fed’s Primary Dealer Survey and Survey of Market Participants indicate that the median respondent has a higher bar of 2.2-2.3% in mind. Goldman had assumed a lower bar because policy would still be very accommodative after liftoff, meaning that inflation should in theory rise somewhat further, and because there might not be that much make-up inflation needed this cycle. But Goldman admits that it is not sure, and Fed officials likely have a range of views. Second, there will be substantial turnover on the FOMC by 2023—in fact, President Biden can appoint four new people to the Board of Governors, a majority—and we expect the new appointees to lean dovish.
Wed, 03/17/2021 – 10:00