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FOMC preview: Fed seeks to downplay rate hike prospects as taper talks advance

The Federal Reserve is not expected to announce any major policy change at the conclusion of its meeting on Wednesday, but markets could jitter from Fed signals that one could be coming soon.

The Fed has signaled that it will likely start pulling back on its extraordinary monetary support before the end of the year. The Fed’s playbook calls for slowing its asset purchase program first, followed by interest rate hikes down the line.

But Fed Chairman Jerome Powell has already communicated to markets that the timing of a so-called taper “will not be intended to carry a direct signal” on the timing of eventual rate hikes.

“Convincing markets of this reality will be more difficult,” Deutsche Bank Research wrote in a note on Sept. 17.

Deutsche noted that Powell will face a “disentanglement dilemma” when the policy-setting Federal Open Market Committee (FOMC) releases its updated set of “dot plot” projections, which will map possible paths for interest rates through 2024. In June, the median member of the 18-member committee signaled the likelihood of two 25 basis point rate hikes by the end of 2023.

Wall Street is scattered on whether or not the economic recovery since June will pull tilt the FOMC toward a more aggressive path to raising rates.

Deutsche and Evercore ISI, for example, expect the Fed to upgrade that forecast to three rate hikes in 2023. BofA Securities and Goldman Sachs see the Fed leaving its 2023 projection alone at two rate hikes. All four expect the Fed’s median dot to show no rate hikes through the end of 2022.

Either way, Powell and the rest of the FOMC will likely attempt to decouple the dot plot from any updates on the Fed’s approach to tapering its $120 billion-a-month pace of asset purchases.

“It’s really important to stress that we have two different sets of metrics for taper and liftoff,” Fed Governor Christopher Waller told Yahoo Finance on Aug. 27.

The prevailing bet on Wall Street is for the Fed to use this week’s meeting to ease into a possible announcement at its next meeting in early November. August data showing fewer-than-expected job gains and cooler-than-expected increases in prices may incentivize Fed officials to wait a little bit longer before pulling back its support.

“I think November’s a reasonable starting point but the good news is that this is a Fed that believes that they have flexibility and optionality, so they’re not required to show their hand right now and they’ll see how this plays out,” said Invesco Global Market Strategist Brian Levitt.

Dark horses

One reason for the Fed to keep its cards close to the chest is the prevalence of other risks that have emerged since the last FOMC meeting in July.

The major downside risk remains the Delta variant, which may have weighed on the August data. Cases rose sharply in August, although the pace of new COVID-19 cases showed signs of slowing toward the end of that month.

But dark horse risks have popped up just in the last few weeks.

Treasury Secretary Janet Yellen has warned of “widespread economic catastrophe” if Congress does not suspend the debt ceiling before the U.S. Treasury runs out of cash to pay its bills.

A vicious market sell-off on Monday has also highlighted stateside concerns over the spillover effects of the possible failure of Chinese real estate conglomerate Evergrande. The flailing firm may fail to make debt payments on a sliver of its over $300 billion in debt later this week, raising the specter of a possibly systemic collapse inside the world’s number two economy.

DailyFX analyst Christopher Vecchio said Powell will not want to spark fear if pressed on either risk in his press conference on Wednesday afternoon.

“It’s going to be a wink and a nod,” Veccio told Yahoo Finance Monday. “It would not be prominent. In making it prominent, it would elevate the fear and that could actually deepen a sell-off which may imperil their best-laid taper plans.”

The Fed’s decision is due at 2 p.m. ET on Wednesday followed by Chairman Powell’s press conference at 2:30 p.m ET that same day.

Brian Cheung is a reporter covering the Fed, economics, and banking for Yahoo Finance. You can follow him on Twitter @bcheungz.

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