How The Fed Can Surprise Investors This Week

Authored by Steven Englander via Standard Chartered,

Investors haircut FOMC projections

End-2019 Fed funds expectations have dropped 22bps since the last FOMC, so investors will likely expect a significantly more dovish tone. We think shifting to one hike each in 2019 and 2020 is roughly neutral for investors.

One + one would convey to the market that the FOMC expects future hikes to be isolated and limited, in line with being ‘data dependent’. In the context of largely positive growth and inflation forecasts, two isolated hikes would be optimistic but not aggressively hawkish. One + one would continue the downward trend in projected Fed hikes. 

We expect initial market uncertainty over whether one + one is sufficiently dovish relative to market expectations. This one + one scenario would leave the peak FOMC projection about 50bps higher than the current level of Fed funds, but we think investors see the FOMC projections as fair-weather expectations, corresponding to, say, the 80th percentile of optimism, not a median or probability-weighted outcome. We think a 50-60bps haircut to the FOMC projections looks about right in market terms. Our economists think the Fed may de-emphasise the dots, but it is unlikely that it will cancel the projections without prior notice. 

By contrast, shifting to a single hike in 2019 and none in 2020 would be unambiguously dovish, despite suggesting rates that are higher than current levels. The market focus would be on the Fed confirming rates are close to a peak. From the investor viewpoint, the indication of a peak would be a signal that the Fed was pretty sure it was close to neutral and risk to policy rates was skewed to the downside.

The one + zero rate-hike projection would probably be accompanied by lower estimates of equilibrium unemployment and policy rates. This would be a powerful signal that FOMC participants have shifted their underlying view of inflation dynamics to the downside and they see only a modest risk that rates would go much higher. Lowering inflation projections in this scenario is unambiguously dovish, but keeping them unchanged is not necessarily hawkish. The Fed may want to signal that a small overshoot is desired.

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