The Federal Reserve is set to leave its policy unchanged and acknowledge better conditions. According to FXStreet’s Analyst Yohay Elam, markets are at a juncture where they cheer growth but dread inflation that could come with it. The Fed has a fine balancing act and it may fail to stay on top of the tightrope.
Key quotes
“Rising growth prospects will likely push the Fed’s long-term inflation forecasts, but these would probably stand around 2%, the bank’s target. That would be a Goldilocks scenario. Seeing only modest rises would soothe market concerns about inflation and also interest rates. Forecasts for tame inflation are positive for stocks and adverse for the dollar. In case the Fed boosts inflation forecasts, markets would fear rate hikes and in case they remain unchanged at low levels, investors would fear a gloomy growth outcome. Bringing the forecast to around 2% would be perfect, and that is the most likely outcome.”
“Even if the bank pushes the unemployment rate projections down, it may stress that many people are out of work. Moreover, Powell is set to give it special attention in his press conference. Full employment is the second Fed mandate, alongside price stability. Balancing concerns of lingering joblessness with upbeat inflation and growth forecasts – the latter unlikely to raise any eyebrows – may keep markets in check. The rise in stocks and yields will likely remain tame.”
“Bond markets suggest the first hike will come in late 2022. If President Joe Biden does not extend the Fed Chair’s term, Powell will be gone early next year and the views of his colleagues will matter more. If three or more foresee conditions necessitating an early hike, stocks would shiver and the dollar could shoot higher. If only one or two change their minds, that is where things may turn ugly. Markets may chop their way around and try to scrutinize every word that Powell says in his press conference. If he seems open to hikes under certain conditions, the ‘risk-off’ scenario of a market sell-off applies. On the other hand, a ‘read my lips’ style pledge to hold rates low until 2023 no matter what could keep markets happy.”
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