Why this week’s Fed meeting could be ‘March madness’ for markets

Chances are high that the Fed will move the markets this week, even if it tries not to.

With interest rates soaring and the economy rebounding, the Fed’s easygoing policies are in the spotlight, and the question increasingly arises of when will it consider unwinding them. Fed Chairman Jerome Powell will likely be asked about the Fed’s low interest rate policies and asset purchases during his press briefing, following the two-day Fed meeting that ends Wednesday.

Powell is not specific, but what he says could shake up the already volatile bond market, which in turn could boost stocks. It could hit growth stocks in particular if bond yields start to rise.

“I think the last press conference, I think I watched with one eye and listened with one ear. This one, I’m going to be listening to every word, and the markets are going to be on. listening to every word, ”said Rick Rieder, BlackRock’s CIO for Global Fixed Income. “If he doesn’t say anything, it will move the markets. If he says a lot, it will move the markets.”

Rieder said the briefing should be “exciting to watch,” and a challenge for the Fed to potentially start changing communications about its policy. He said investors will analyze every word. “It will be the madness of March,” for the markets, he said, referring to the highly anticipated college basketball tournament.

Powell clearly has the ball, and what he decides to say on Wednesday will dictate to edgy markets how soon the Fed might consider cutting its bond purchases and even raising interest rates from zero.

The Federal Open Market Committee will issue its statement at 2 p.m. ET on Wednesday, after the meeting, and Fed watchers expect little change in the text.

But the Fed is also releasing officials’ latest forecasts on the economy and interest rates. This could show that most officials would be ready to raise the target federal funds rate range to zero in 2023, and that a few members might even be ready to hike rates next year.

“We think they will appear a little more optimistic but still cautious. That said, we think it will be difficult for them to appear as accommodating as they have been just because the facts on the ground are improving. “said Mark Cabana, head of US Short Rate Strategy at Bank of America. “As a result, we think they are going to look a little less accommodating than the market expects. We think they are likely to post an increase at the end of 2023.”

Rieder said the Fed routinely runs its easing programs, but now needs to start communicating that it plans to change policy on both asset purchases and interest rates. He said the Fed has been explicit in that it will allow a lot of time between when it starts communicating the change and when it acts.

“It seems to me that it is time,” he said. Rieder said his non-consensus view is that the Fed may start cutting its bond purchases in September or December, and it should start discussing it now. The Fed buys $ 80 billion a month in treasury bills and $ 40 billion a month in mortgages.

He also said the Fed could also start raising short-term interest rates next year without hurting the economy. The Fed hasn’t forecast any interest rate hikes until 2023, but that could change in its latest forecast.

“They can’t raise short interest rates this year, but there is no reason, as you move into the second and third quarters of next year, that they could raise interest rates. short term that don’t match their expectations, ”Rieder said.

The Fed faces lower rate volatility in the more generally frozen Treasury market. Over the past six weeks, the 10-year yield, which affects mortgage and other loan rates, has climbed from 1.07% to a high of 1.64% last Friday. It was 1.6% on Monday.

Yield, which moves opposite of price, reacted to a more optimistic view of the economy, based on vaccine rollout and Washington’s stimulus spending. He also reacted to the idea that inflation could pick up as the economy rebounds. Powell said the Fed expects to see only a temporary rise in inflation measures in the spring due to lower prices during last year’s economic shutdown.

“They have to start this communication … the markets are waiting for it,” Rieder said. “The nervousness of rates and the volatility of the market are due to the fact that we have not yet heard their plan.”

Rieder said the Fed could raise interest rates while still buying bonds. He said he might want to shift his purchases more to the long term to keep long-term rates low, as they impact mortgages and other loans.

“In their economic projections, their employment projections for next year will likely be 4%. If that’s true, why not? Raise short-term interest rates and drain some of the game’s liquidity forward of the yield curve is not a problem, ”he said.

“Times like these call for creativity and innovation,” said Rieder. “They have been remarkably innovative. They have provided so much liquidity to the system, the front end is inundated with liquidity and the yields are too low, in an environment where you could have 7% growth this year. ”.

In the latest forecast, five out of 17 members expected a rate hike in 2023, and only one predicted a hike in 2022. Fed officials provide their rate forecasts anonymously, on a so-called point plot .

The Fed has said it will continue buying bonds until it makes “substantial progress” towards its targets.

Cabana said a few officials could now forecast a hike for 2022, but he doesn’t expect the Fed to accept it yet. The federal funds futures market is pricing close to one rise in 2022 and three hikes by the end of 2023.

“You think if the market assesses this and the Fed doesn’t deliver, the market should be disappointed. We actually think a lot in the market thinks the Fed is going to push back, and the Fed will tell the market that’s wrong. “said Cabana. “We don’t think so. We think the Fed will retain the option of having the market price from a rosier perspective. Is the Fed hoping the market is right, or are they right? The Fed is hoping that the market is right because it wants to hit its target sooner. We don’t think the Fed is going to push back too much. “

The Fed could say that “substantial progress is still in some time,” Cabana said. He said he expects the Fed at some point to change the length of the bonds it purchases and move towards the long term to prevent these rates, like the 10-year, from rising too much.