Global Daily – All eyes on the Fed dots
March FOMC Preview: Committee likely to project one rate hike by 2023. The FOMC convenes for its two day policy meeting from today, with the outcome and accompanying press conference on Wednesday. The key focus for markets will be the new economic projections, and in particular the FOMC’s ‘dots’ projections for the path of interest rates.
Co-author: Jolien van den Ende
With regards the economic projections, we expect a significant upgrade to growth forecasts to something near our own (we expect growth of 6.2% Q4/Q4 for 2021, compared to the Fed’s December projection of 4.2%). PCE inflation should also get an upgrade for this year given the jump in oil prices, but expectations for 2022 and 2023 will likely remain around 2%. Market participants have significantly brought forward their expectation for rate hikes following the Democrat win of two Senate seats in early January, which paved the way for the recently-passed $1.9trn fiscal relief package (and which is likely to mean more significant spending still to come on infrastructure and renewable energy). The latest Bloomberg survey of economists shows that consensus now expects two rate hikes by 2023, whereas previous surveys showed the first rate hike coming in 2024 or later. Meanwhile, financial markets expect the equivalent of 2.5 hikes by early 2024; this compares with our own expectation for just one rate hike.
As we have discussed previously, we think market expectations for rate hikes have got ahead of themselves given the outlook for inflation and given the Fed’s new average inflation target. However, there is still uncertainty over how the Fed will apply its new target in practice, and this has been fueled by a lack of clarity from Fed officials over how it views the effects of the fiscal spending coming on stream. While 2023 is too far ahead for the Fed to give a great deal of clarity at this stage, the new rate projections should help somewhat. We expect the median FOMC member to pencil in one rate hike in 2023; notably less than the 2.5 hikes implied by financial markets. The Bloomberg survey shows most economists expect the Fed to signal zero rate hikes in 2023, which is somewhat surprising, although we would caution that the sample of this survey is not fully representative, with many large financial institutions missing from the responses. As such, we think projections pointing to no more than one rate hike in 2023 should still have an anchoring effect on the market, thereby keeping a lid on further yield rises. We see room for short term rates 2y ahead in particular to fall back, reflecting reduced rate hike expectations. (Bill Diviney & Jolien van den Ende)