This week’s Federal Open Market Committee meeting will mark an important shift away from the Federal Reserve’s dovish stance expecting increases in inflation as the US economy reopens to be ‘transitory’. We think investors should look for the following from the FOMC meeting.
Statement: the FOMC will keep fed funds at 0.00-0.25% but will recognize the strong US recovery and stop describing inflation as transitory.
Monetary policy: officials will taper bond buying faster and end quantitative easing in March rather than June given inflationary pressures. On Friday, November’s consumer price index (CPI) report showed headline inflation hit 6.8%, its highest level since 1982. Similarly, core inflation, excluding food and energy costs, rose to 4.9%, a 30 year high as the chart shows. We thus expect the Fed will cut its bond buying by USD30billion each month and finish printing money in March.
Forecasts: an early end to quantitative easing will allow the Fed to raise interest rates in 2022 (rather than wait until 2023 as we have been expecting). Thus, the FOMC’s new forecasts will be closely followed. We expect officials will lower their unemployment projections and raise their inflation forecasts given the strong US recovery. We see the ‘median’ forecasts for the fed fund rate - the interest rate ‘dots’ - will show two 25bps increases in 2022 and four each in 2023 and 2024. This slow quarterly pace of rate rises would be similar to the Fed’s last hiking cycle in 2017-2018.
Source: Bank of Singapore, Bloomberg.
It would also bring the fed funds rate up from 0.00-0.25% to 2.50-2.75% as occurred in 2018. This is the neutral level where the FOMC anticipates the fed funds rate should be in the ‘longer-run.’
Lift-off timing: interest rate markets have already priced in three 25 bps increases in the fed funds rate in 2022. Thus, the timing of when the FOMC will start raising interest rates will be key. Indications this week for an imminent start in March once quantitative easing finishes would hit risk assets. Investors would worry if the Fed was behind the curve and may hike rates more quickly than a slow pace of once a quarter. In contrast, signals from the Fed that it will wait until the summer or September would likely be a relief.
Press conference: Chairman Powell is set to stress the Fed has not yet met its goal of maximum employment. November’s payrolls report showed the US is still almost 4 million jobs short of pre-pandemic levels. Powell may also note increased uncertainty from Omicron. And while inflation has clearly breached the Fed’s 2% goal, the Fed Chair is still likely to expect consumer price rises will fall significantly next year. November’s CPI report showed rents are rising more firmly - a persistent source of inflation - but upward pressure on used cars and accommodation costs will ease as the economy fully reopens. We thus expect Powell to stress the bar for starting rate hikes is higher than for finishing quantitative easing, helping to avoid any taper tantrums for risk assets as 2021 ends.
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