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Why this week’s Fed meeting could be “March madness” for the markets

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Federal Reserve Chairman Jerome Powell speaks during a House Select subcommittee on the coronavirus crisis hearing on September 23, 2020 in Washington, DC, United States.

Stefani Reynolds | Reuters

Chances are the Fed will move the markets this week, no matter how hard it tries not to.

With interest rates rising and the economy recovering, the Fed’s loose policy is in the spotlight and the growing question is when it will consider winding it up. Fed chairman Jerome Powell is likely to have questions about the Fed’s low interest rate policy and asset purchases during his press conference after the Fed’s two-day meeting, which ends Wednesday.

Powell isn’t specific, but what he says could shake the already volatile bond market, which in turn could drive stocks. Growth stocks in particular could be hit if bond yields begin to rise.

“I think the last press conference, I think I watched with one eye and listened with one ear. I’ll tune this to every word and the markets will be tuned to every word.” said Rick Rieder, BlackRock’s CIR 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 see” and a challenge for the Fed, possibly to begin changing communications about its policy. He said investors will analyze every word. “This is going to be March madness,” he said for the markets, referring to the highly anticipated college basketball tournament.

Powell clearly has the ball, and what he decides to say on Wednesday will tell nervous markets when the Fed might consider scaling back its bond purchases and even hike rates from zero.

Statement to mostly stay the same

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

The Fed also publishes the officials’ latest forecasts for the economy and interest rates. This could show that most officials would be ready to raise the rate range on Fed funds from zero in 2023, and some members may even be ready to raise rates next year.

“We believe they will sound a little more optimistic but still more cautious. However, we believe that it will be difficult for them to sound as cautious as before just because the facts on the ground improve,” said Mark Cabana, director of US short rate strategy at Bank of America. “Because of this, we believe they will sound a little less accommodative than the market expects. We believe that they will likely show a hike by the end of 2023.”

Rieder said the Fed has been steadily steering its easing programs, but now it needs to start communicating that it expects a change in policy on both asset purchases and interest rates. He said the Fed had specifically advised that it would allow ample time between starting communicating changes and taking action.

“I realize it’s time,” he said. Rieder said his disagreed view is that the Fed could start scaling back its bond purchases in September or December and needs to start discussing it now. The Fed buys $ 80 billion a month in government bonds and $ 40 billion a month in mortgages.

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

“You cannot raise short-term interest rates this year, but there is no reason to raise short-term interest rates in the second and third quarters of next year that are inconsistent with your projections,” said Rieder.

prices are increasing

The Fed is countering a decline in interest rate volatility in the rather stable Treasury market. Over the past six weeks, the 10-year rate of return that affects mortgage rates and other credit has increased from 1.07% to a high of 1.64% last Friday. It was 1.6% on Monday.

The return, moving against price, has responded to a more bullish view of the economy based on the vaccine rollout and stimulus spending in Washington. It has also responded to the idea that inflation could rise if the economy returns. According to Powell, the Fed expects inflationary measures to spike only temporarily in the spring as prices were depressed during last year’s economic stalemate.

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

Rieder said the Fed could raise rates while it was still buying bonds. He said it may want to shift its purchases more towards the long end to keep longer-term interest rates low as they impact mortgages and other credit.

“In their economic forecast, their employment forecast for the next year is likely to be 4%. If that’s true, why not? Raising short-end interest rates and draining liquidity from the front of the yield curve is not a problem,” he said.

“Times like these require creativity and innovation,” said Rieder. “You’ve been remarkably innovative. You’ve added so much liquidity to the system that the front end is full of liquidity and returns are too low in an environment where you could get 7% growth this year . “

In the last forecast, five out of 17 members expected an interest rate hike in 2023 and only one member expected an interest rate hike in 2022. Fed officials submit their interest rate forecasts anonymously on what is known as a dot chart.

The Fed has announced that it will continue its bond purchases until it has made “significant progress” in meeting its targets.

Cabana said there might be some officials now forecasting an increase in 2022, but he doesn’t yet expect the Fed to accept it. The Fed Funds Futures market expects one hike in 2022 and three hikes by the end of 2023.

“They think if the market prices this in and the Fed doesn’t deliver, the market should be disappointed. We actually believe that many in the market believe that the Fed is going to backtrack, and the Fed is going to tell the market that it is wrong “said Cabana. “We don’t think so. We believe the Fed will keep the option to keep the market price on a rosier outlook. Does the Fed hope the market is right, or are they right? The Fed hopes the market is right?” because it wants to get there sooner. We don’t think the Fed will push back too hard. “

The Fed might say “substantial progress is still some time away,” Cabana said. He said he expected the Fed to change the maturity of the bonds it bought at some point, shifting towards the long end, to keep those rates from rising too much like the 10-year bonds.

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Katherine Clark