The Federal Reserve of the United States (Fed) is holding its FOMC meeting and press conference two days from now. While no change is expected at this meeting, the focus shifts to the way the Fed communicates its intentions and to future economic projections.
Two things influenced financial markets recently. First, the rise in the long-term interest rates. Long-term bond yields tend to rise when the economic recovery picks up, but the move higher triggers unwanted tightening of financial conditions. Second, the new round of fiscal stimulus approved in the United States led to global GDP growth projections to rise by 1% or so.
At Wednesday’s meeting, the Fed must find a way to communicate markets that, while remaining accommodative, it still accounts for stronger economic growth. How to do that without being hawkish? The answer lies in the Fed’s “dots”.
The Focus on the Fed’s Dots
This week’s Fed decision is followed by the regular press conference. However, Wednesday’s event is a special one because the Fed will present its economic projections.
For financial markets, a certain part is extremely important – the one that shows the FOMC members’ future rate projections. More precisely, each member projects the federal funds rate for the next three years. The projections are then averaged and a dot is plotted on a chart showing the potential increase or decrease of future rates. At this meeting, the Fed’s challenge is to show its willingness to keep an accommodative monetary policy and, at the same time, to account for future growth. The dots may help to send the right signal.
In other words, the “dot plot” is unlikely to signal a rate hike before 2024. However, the decision to signal or not a liftoff in 2023, for instance, is not an easy one. Some voices argue that if the Fed decides to signal a liftoff in 2023, such a decision would be counterproductive. Why would the Fed do so?
The main argument comes from inflationary pressures. The months ahead will likely put the Fed under pressure as inflation is projected to overshoot the 2% target. By signaling a rate increase in 2023, two years from now, the Fed may choose to strike first, preemptively, to taper higher inflation expectations. The risk, however, is that such a move will weaken its forward guidance.
One thing is for sure – whatever the Fed decides on Wednesday, the USD’s volatility will be higher than average.