FOMC Preview: Downshift Unlikely to Stir Markets

Summary

• Alongside consensus, I expect a 25bp hike at the 1 February FOMC meeting.
• Since the December 2022 meeting, the macro backdrop of lower inflation and strong employment growth has decisively validated neither hawks nor doves.
• Therefore, I expect Chair Jerome Powell to link any possible policy changes to the economy’s deviations from the December 2022 SEP trajectory because that is the de facto compromise between hawks and doves.

Market Implications

• Because of the ambiguous macro backdrop, Powell is unlikely to be hawkish enough to get markets to price a December 2023 FFR nearer the SEP.

Meeting Context

Markets are pricing a 25bp hike to 4.50-4.75% at the 1 February FOMC meeting, and I agree.

The last we heard from Chair Jerome Powell on the economic and policy outlook was at the 14 December FOMC meeting when he gave a hawkish presser. He stated that:

• An increase in the inflation target is unlikely soon.
• ‘We are not at a sufficiently restrictive stance yet.’
• While lower CPI prints in October and November were welcome, ‘it will take substantially more evidence to give confidence that inflation is on a sustained downward path.’
• ‘I can’t tell you confidently that we won’t move up our estimate of the peak rate again at the next SEP.’

Since then, the minutes conveyed new FOMC concerns over a rebound in growth as well as weak transmission of policy tightening to the real economy.

Economic developments since the 14 December FOMC meeting broadly paint a picture of continued labour market strength, growth at or above trend, and inflation moderation (Table 1; for full account of FOMC participant comments, see Table 2). 

This macro backdrop supports both dovish views (inflation is slowing) and hawkish views (the labour market remains very tight, and growth is not slowing below trend). It gives Powell no grounds to tilt very dovish or very hawkish. Therefore, I expect him to stick to the macro scenario and FFR trajectory in the December SEP – that is, in effect, the current compromise between hawks and doves.

Key Questions

Powell’s presser next week is likely to discuss the same themes Governor Christopher Waller addressed last week in his Q&A. These are the inflation outlook, how much further the Fed is likely to tighten, and what it would take for the Fed to cut. 

On the inflation outlook, I expect Powell to take a similar line to Waller. That is the Fed needs more data to be confident that inflation is on a sustainable downward path. This is hard to dispute given the extreme inflation volatility since 2021 (Chart 1).

On what it would take for the Fed to cut, Waller stated last week he would need inflation to continue to slow through the summer and see signs of slower growth and an easing labour market to consider a policy change. 

Powell tends to give less specific answers. Instead, I expect him to refer to the December SEP. That is, he could say that once the Fed is confident inflation is slowing faster than in the SEP, the Fed could consider a policy change – without providing a specific timeframe.

Powell could also stress that the Fed assessment of inflation risks involves not only inflation prints but readings of resource pressures in the goods and labour markets.

I also expect Powell to say that if the data pointed at a resurgence of inflation, the Fed could lift the terminal rate and that 50bps at the next FOMC meeting is possible ‘based on incoming data and financial conditions.’ He made a similar statement in December but to limited market effect; I do not expect much market impact this time either.

Market Consequences

Markets are currently pricing a December 2023 FFR at 70bps below that in the December 2022 SEP. Powell seems unlikely to get markets to raise the FFR nearer the SEP.

Dominique Dwor-Frecaut is a macro strategist based in Southern California. She has worked on EM and DMs at hedge funds, on the sell side, the NY Fed, the IMF, and the World Bank. She joined Macro Hive soon after its inception.

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