Federal Reserve Chairman Jerome Powell reacts as he testifies before a Senate Banking, Housing and Urban Affairs Committee hearing on the “Semiannual Monetary Policy Report to Congress,” on Capitol Hill in Washington, DC, USA, June 22, 2022.
Elizabeth Frantz | Reuters
The Federal Reserve is expected to raise interest rates by another three-quarters of a point on Wednesday, and could surprise markets if it sounds even more relentless about policy tightening.
That means the Fed would sound “hawkish,” or in a mode where it is determined to raise interest rates as much as needed to curb inflation. The central bank is expected to announce the rate hike on Wednesday at 2pm ET. Fed Chairman Jerome Powell briefs the media at 2:30 pm ET.
A hike of 75 basis points, or three-quarters, would put the fed funds rate in a range of 2.25% to 2.5%. The Fed began raising interest rates in March, when the fed funds range was zero to 0.25%.
Investors will look to Powell for guidance on what the Fed might do at its next meeting in September. For a period this month, markets had even braced for a full hike, but Fed officials discouraged that view.
“I think they will tilt a little bit more in September,” said Jim Caron, head of global fixed income macro strategies at Morgan Stanley Investment Management. “They’re just not seeing the progress of inflation.”
‘Conversation of two-handed economist’
The Fed could offer new comments on the economy, which it may acknowledge is slowing.
“There’s going to be a lot of economist talk on the hands of Jay Powell,” said Vincent Reinhart, chief economist at Dreyfus and Mellon. “It will say that we are definitely going through a soft inventory and business cycle.”
Reinhart said that while Powell should acknowledge slower growth, the president can also say that there is fundamental support for the economy. The job market is still strong although unemployment claims have started to rise.
“I think it’s going to be a mixed bag. It’s going to talk before what could be another quarter of real GDP decline,” Reinhart said.
The Fed’s two-day meeting ends on the eve of Thursday’s release of second-quarter gross domestic product, which some economists expect will show a contraction. That would suggest the economy could be headed for recession, and some believe it would technically be in one because it would be the second negative quarter in a row.
However, the National Bureau of Economic Research uses other criteria to judge a recession, and is not yet expected to declare one, Reinhart said.
Still, some traders are betting that the Fed will eventually trigger a recession with aggressive policy tightening. Powell is expected to tighten the Fed’s rate hike path, and that could turn out to be false.
“I could talk about the cycle going well into next year,” said Michael Schumacher, director of rate strategy at Wells Fargo. “The market is pricing in a pretty quick end to the hiking cycle. That’s not realistic. I think that’s going to sound pretty hawkish.”
The futures market is actually pricing in the Fed next year. Traders are betting that the Fed will start cutting rates next spring, after taking the funds rate to 3.4% later this year.
“Inflation is not going down”
For now, hot inflation is likely to keep the central bank raising rates. The consumer price index rose 9.1% in June, the highest consumer inflation since November 1981.
“We have yet to see the fall in the sequential core CPI,” Caron said. “To me, if that’s a significant threshold for them, they’re going to continue to be aggressive. They could communicate that. That would look hawkish.”
Core CPI, excluding energy and food, rose 0.7% in June from 0.6% in May.
Caron said a hawkish Fed could cause shorter-dated Treasury yields to rise and stocks to sell off after the meeting. If longer-dated yields, such as the 10-year Treasury note, continue to fall on recession fears, the yield curve will invert further.
The yield curve inverts when shorter-dated yields, such as the 2-year Treasury, rise above longer-dated yields, and is often seen as a warning of a recession. The 2-year, which more closely mirrors Fed policy, yielded about 20 basis points higher than the 10-year on Monday.
“Major problem: Inflation is not coming down,” Caron said. “They won’t really tell you that, but that’s the problem.” He added that the Fed will not be deterred by falling asset prices as rates rise.
“They can’t say they’re outpacing inflation. They can’t even say they’ve had a successful month in a row,” Caron said. “They will probably say that policy interest rates help slow the economy. It works with a lag.”
Many voices at the Fed
Diane Swonk, chief economist at KPMG, said Powell’s job will be more difficult because there are differing opinions at the Fed about whether it should hike more or less.
“There’s still going to be debate at the Fed. You suddenly have a lot of voices. This is the first time they’ve had a full staff and you’ve got more Fed chairs,” he said. “There is debate about whether they are going faster or slower now. The message becomes more complicated for Powell, given the diversity of views.”
Powell may also be more vague than at the last meeting and leave his options open when it comes to September.
“In recent meetings, Chairman Powell has signaled (or mis-signaled) the expected size of the rate move at the next meeting. We don’t expect it to be that definitive,” said Michael Feroli, chief economist at JPMorgan. “While it will almost certainly signal that the committee expects to continue to tighten policy, with two employment reports between now and the September meeting, we do not see the advantage of putting a stake on the floor at the end of July. It is very Powell is likely to get asked about the possibility of a recession; we suspect he’ll say it’s a risk but not a foregone conclusion.”