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June 16, 2021, 8:42 a.m. EDT

Fed likely to make hawkish sounds but don’t be fooled

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Greg Robb

There are sixteen different types of hawks found in the United States, according to birdwatchingh.com . While it may be tempting, it is too soon to add Federal Reserve policymakers to that list.

Much will be made next week out of some potentially “hawkish” sounds from the U.S. central bank’s policy meeting, economists said, while they stressed that Fed Chairman Jerome Powell and the majority of the voting members of the interest rate setting committee remain “doves” and fundamentally will be sticking to their “patient” stance on monetary policy.

“They are going to be a little bit less dovish than last time,” said Jim O’Sullivan, chief U.S. macro strategist for TD Securities. 

U.S. inflation has been sizzling in recent months.

See: U.S. consumer prices soar again in May

But the recent decline in long-term Treasury yields /zigman2/quotes/211347051/realtime BX:TMUBMUSD10Y 0.00% allows the Fed to lean into the hawkish message, O’Sullivan said.

While inflation has been surprisingly hot, the Fed “is willing to wait” until the fall to see how the labor market responds to the inflation spike, said Ian Shepherdson, chief economist at Pantheon Macroeconomics. Wage pressures play a key role in determining the inflation outlook.

“We don’t know how many people will come back into the labor market, how participation will rise, and will it be enough to dampen inflationary pressures,” Shepherdson said.

“In the olden days, the Fed would have raised interest rates first and worried about what was going to happen afterwards. But this is a different Fed with a different strategy and a different approach,” he said. 

The Fed is buying $80 billion of Treasurys and $40 billion of mortgage backed securities each month, along with keeping its benchmark interest rate close to zero, to support the economy.

The central bank put itself in a bit of a box in December by guiding markets that it wouldn’t slow down the pace of purchases until there had been “substantial further progress” in its goals of full employment and stable inflation. 

What will be the hawkish sounds?

First, the Fed will give in to the reality that talking about tapering the size of its asset purchases makes sense. This is an important shift. Since December, Powell has managed to hold off such talk. 

But this is only the most preliminary of steps. 

Instead “officials will talk in general straw-poll terms on what principles ought to apply,” said Lou Crandall, chief economist at Wrightson ICAP.

It won’t be the Fed having a structured debate on a set of options game-planned by the staff. That might happen in July, but not now. 

To downplay the significance, the Fed won’t say anything about the “talks about tapering” in its formal statement, later Wednesday afternoon, O’Sullivan said. 

Secondly, the Fed’s dot-plot, or interest rate forecast chart, may show a shift forward for the first rate hike to come during 2023. At the moment, the Fed shows no rate hikes until 2024 at the earliest.

At its March meeting, seven out of 18 Fed officials saw a hike before the end of 2023, and it could be nine or ten officials at the June meeting next week.

Thirdly, the Fed will have to raise its forecast for inflation for this year. In March, the Fed penciled in a 2.2% core rate for the personal consumption expenditure index. While that may rise, the Fed won’t move the core rate for 2022 much higher, a signal that it still believes the price gains seen in the last few months reflects “largely transitory” factors. 

During press conferences, Powell has said the economy is “a long way” from the Fed’s goals and it would take “some time” for substantial further progress to be achieved.

“I wouldn’t pound the table and say exactly what Powell is going to say but it is time to start getting away from that language,” O’Sullivan of TD Securities said.

At the same time, the Fed has got to say that while the economy has made progress, they still need to see a lot more,” he added.

When the Fed added the “substantial further progress” guideline, the economy was 9.8 million jobs short of its level in February 2020. At the moment, the economy is 7.6 million jobs short.

None of these potentially hawkish noises will disturb the central message of Fed officials to the market — that its benchmark interest rate will stay low next year.

Even if the Fed starts to taper its asset purchases next January, economists think it will take months before the central bank is ready to take the next step and hike its benchmark interest rates off zero.

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