What will the Fed do after this week’s key meeting?

After the turmoil in the financial markets on Monday, the challenge for the Federal Reserve is to reassure investors while recognizing that it is preparing important steps to first move away from the expansionary monetary policy it is using to combat the Covid19 pandemic .

The Fed will issue a monetary policy statement along with its quarterly economic and interest rate forecasts at the end of its two-day meeting on Wednesday afternoon. Fed chief Jerome Powell is expected to respond to the media on Thursday at 1:30 a.m. KST. Powell is expected to be ready to announce that the Fed will begin reducing its monthly purchases of $ 120 billion in government bonds and guaranteed securities.

“I think they would say they had a discussion about reducing the support package. I don’t think they’ll give any details. I think they’ll provide a framework so they can start doing this in November or December, “Rick Rieder, BlackRock’s chief investment officer, global bonds, told CNBC.

The Fed meeting kicks off Tuesday (US time) after a volatile day in global markets amid fears that giant Chinese real estate developer Evergrande could collapse and spread the virus outside the Chinese border. The S&P 500 had its worst day since May on Monday. Shares stabilized somewhat on Tuesday as investors expected the Chinese government to step in to contain the situation.

“Has the price movement of the last few days on the market or in China influenced your thinking? I think they will start in the discussion, but I still think they will end up in the same place we should be, “said Rieder.

He expects the Fed to cut $ 10 billion a month in Treasury purchases and $ 5 billion in guaranteed securities.

What can change the market?

“Overall, the cut in support is unlikely to be a market changing event,” said Anwiti Bahuguna, director of multi-asset strategy at Columbia Threadneedle. She noted that during the meeting there will be a lot of focus on the Fed’s forecasts and the “dot plot,” the chart used to present interest rate forecasts by central bank officials.

While the Fed’s gradual reduction in asset purchases is well reported, strategists say the Fed’s rate forecast could be an unpredictable asset for the markets. Closely related to this would be the Fed’s inflation expectations. In June, the inflation forecast for private spending was 3.4% for that year, before falling to 2.1% in 2022.

Also in their June forecast, Fed officials were aiming for two rate hikes in 2023, but the risks could change. There are two Fed officials forecasting the first spike in 2022, and many market pundits are betting on a spike by the end of next year.

“If we just see two or three members change their minds, it could be a political hawk. Fed officials are unlikely to remove the dots, so there is a risk that more dots will pop up in 2022 and 2023 and the market is starting to believe that the 2020 rate hike cycle will begin. is negative for stocks and could lead to higher interest rates.

* Hawkish Policy is used to describe the view of a tight monetary policy with high interest rates, a tight lending policy and always warnings about inflation risks. The opposite of a restrictive policy is the dovish, who prefers a monetary policy with the lowest possible interest rates, coupled with easy credit, in order to achieve economic growth and employment goals. Fed officials will gravitate towards either of these two measures depending on market conditions.

In June, the addition of interest rate points to the 2022 forecast came as a surprise, showing that some Fed members see the rise in inflation as more than temporary, Bahuguna said. There is a risk that this could happen again if more Fed officials believe inflation is more persistent.

Powell has repeatedly insisted that he believes the rise in inflation will be temporary, but some Fed officials have rejected the idea.

Consumer price index inflation has risen to over 5% in the past three months, although the pace slowed slightly in August.

Rieder does not expect the Fed to change its interest rate forecast for 2022, although it will publish its forecast for 2024 for the first time. Those long-term projections change often, he said.

Push back the rate hike

Rieder said the Fed would make the contraction look more cautious by stressing that the end of the bond purchase program does not mean a rate hike is imminent. However, the bond market will continue to focus on forecasting rate hikes and inflation.

“Powell will likely do his best to distinguish and decouple the link between lower and higher rates,” said Mark Cabana, head of Bank of America’s short-term rate strategy:

“We assume that they will adjust their macroeconomic and inflation forecasts slightly. We therefore expect them to see growth this year based on some soft recent data. They will add inflation to the steady increases we see. The real focus will be on the points. We assume there will still be no increases in 2022, but they will increase in 2024. We predict there will be three more hikes in 2024. “

Rieder is a supporter of the Fed to optimize its accommodative policy. He said Fed policies and the economy are no longer functioning as they used to.

“I think there is something important here,” he said. “For our generation, we’re used to the fact that monetary policy is often the driver of adjustment when the data is falling … but the softness of the data only comes from the supply side, which is not influenced by the supply side itself.

Demand is high, but supply chain problems and bottlenecks have slowed the economy. The Fed has contributed to this momentum by stimulating the economy through loose policy.

Market experts also expect Powell to respond to the recent controversy surrounding the ownership and trading of securities by Fed officials. The disclosures show there are three owners of the same assets that the Fed bought itself last year, including Powell, who holds municipal bonds. Boston Fed President Eric Rosengren invests in REITs and Dallas Fed President Rob Kaplan owns corporate bonds. The transactions appear to be according to Fed rules and the Fed is conducting a review.

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Qin Shi Huang

According to CNBC

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