Focus on Fed’s rate hike message this week

The Fed entered into the new year needing to reset its credibility to control inflation at nearly a 40-year high. It has been nimble since its hawkish turn last fall as it doubled the pace of QE taper, brought forward the date of rates lift-off, and increased the number of anticipated rate hikes without two months.

Counterbalancing this newfound agility is the Fed’s longstanding policy to provide forward guidance well ahead of any policy change. The challenge for Powell, at the January Fed meeting on Wednesday, is to telegraph a March rate hike in a manner that leaves room for the Fed to move more or less hawkish, perhaps even leaving space for a 50-basis point hike, as some traders have priced in the past week.

The Fed’s preferred price and wage gauges (ECI and PCE deflator) will be released a few days after the FOMC meeting, and we expect both to show elevated inflation pressure.

FOMC rate decision

We are foreseeing rates to remain steady with the current pace of taper to be maintained at the January meeting. The main goal of the meeting is for the FOMC to telegraph a March rate hike and balance-sheet runoff this year, emphasizing the uncertainty and downside risks to growth amid the Omicron wave.

There, most likely, will be a substantial discussion of balance-sheet runoff. At the post-meeting press conference, Fed Chair Powell will provide more guidance, as hinted in the December FOMC meeting minutes.

This new guidance will suggest an appropriate interest-rate hike at the next meeting in March. The FOMC will also anticipate a balance-sheet runoff to start once rates normalization is underway but will not provide clear calendar-based guidance on the timing of runoff.

We expect that a signal of when and how balance-sheet normalization would happen will come only at the March meeting when the committee will issue a detailed addendum to policy normalization principles and plans.

Both the statement and Chairman Powell’s remarks at the press conference will characterize labor market conditions as tight, having been improving rapidly before Omicron but might weaken temporarily in the coming months.

Powell likely will touch on the possibility of a 50-basis point hike at the March meeting. He should mention that it is not something most on the committee currently are anticipating. What would be most interesting for us is if he couches that answer in conditionals and does not completely dismiss the possibility.