The yield on the 10-year Treasury note jumped to its highest in more than a year on Wednesday, while the dollar index edged higher after touching the 92 mark. The three major U.S. stock indexes were mixed, with the Nasdaq and S&P 500 falling under pressure, while the Dow bucked the trend. Spot gold fell as the dollar and U.S. bond yields rose. For now, investors await the outcome of the Fed’s two-day policy meeting and a speech by Fed Chairman Colin Powell later in the day. The Fed will also release new forecasts for the economy and interest rates, which could show that Fed officials expect to raise rates in 2023 or even earlier.
Powell may falk on Fed decision
Now, all eyes are on the Fed’s policy statement, due at 2 a.m. Beijing time, and Fed Chairman Colin Powell’s press conference that follows.
An economic recovery, spreading inflation and a rising stock market do not seem like a good way to loosen monetary policy. But that’s where the Fed is.
The Fed’s challenge this week will be to explain that stance to investors and reassure them that even if the economy stays as it is, it will not prompt policy makers to change course, nor should they.
“The basic case is, ‘Everything looks a little bit better, but there’s still a lot of uncertainty and we’re not going to do anything anytime soon. ‘” said Bill English, a finance professor at the Yale School of Management and former head of the Federal Reserve’s monetary affairs division. “I believe we will hear that.”
“They do want to show that things are getting better,” he said. “On the other hand, they don’t want to suggest that they’re going to change policy anytime soon. So it’s a subtle form of communication.”
There has been speculation in recent weeks that the Fed will adjust its bond-buying programme to lower longer-term interest rates. Longer-term interest rates have jumped to pre-outbreak levels this year and have led to stock market volatility. Mr Powell rejects this view. The Fed holds a policy meeting that could shed light on the timing of future rate hikes and how much the central bank will tolerate higher yields.
Investors will get a sense of the outlook for Fed monetary policy through a dot-plot of the expectations of individual Fed members.
“On the surface, everyone agrees with the new framework, but it may not be the same for everyone,” said Tom Graff, head of fixed income at Brown Consulting. It may not mean that [some members] are hawkish, they just think that this average inflation targeting regime will be different from what Powell did.”
As a result, markets may have to decide for themselves which policy “points” are moving towards a rate rise. According to Citigroup, the market is already pricing in the possibility of three rate hikes by the end of 2022 and 2023. The Fed’s current estimate is that it will not take any action until at least 2024.
They do want to show that things are getting better. On the other hand, they don’t want to suggest that they’re going to change policy anytime soon. So it’s a subtle way of communicating.
“It’s going to be interesting because how can you raise your GDP forecast to 7 percent, your inflation target to 2 percent, your unemployment forecast to 5 percent and say we’re going to be very accommodative,” said Kathy Jones, chief fixed income strategist at Charles Schwab. Patience is the emphasis.”
Jones said she did not expect policy to change yet, and Powell stressed the importance of “creating jobs and reducing unemployment as broadly and inclusiveness as possible before they even consider raising rates.”
“They were happy to wait,” she said.
English, a former Fed official and professor at Yale University, said Powell will stress “uncertainty” despite the outbreak and economic progress.
“Part of the communication is going to be, ‘Our response function hasn’t changed. We still want to achieve our goal and we will still be patient, ‘” he said. “The most likely outlook is better, but the world is an uncertain place. A lot of things can happen.”
ForexLive analyst Justin Low wrote that the Fed has a long way to go today, but in all likelihood, it will simply reiterate what markets have been doing for the past few weeks. We can expect something from the Fed today, but essentially, Powell and his colleagues will try to maintain a more dovish stance. In the previous forecast, there were five points pointing to at least one rate rise by 2023, and that number is sure to rise later today. But the big question is, how much is it going to go down and what is the median after that. If the median reflects a Fed rate hike by the end of 2023, that will only help to reassert market pricing and seriously undermine the Fed’s commitment to “keep rates lower for longer”. In essence, if the median is signalling a rate rise, then what Mr Powell has to say may not matter so much, unless he explicitly points to this particular shift in forecasts.
Market action: Financial markets were cautious as the Fed’s ‘most important meeting in years’ hit
On Wednesday, the Fed will release new forecasts for the economy and interest rates that could indicate that Fed officials expect to raise rates in 2023 or even earlier. The Fed is expected to acknowledge an acceleration in economic growth, which will put the spotlight on the central bank’s accommodative policies, especially given the $1.9tn in new federal stimulus spending.
Fed policymakers expect the US economy to grow at its fastest pace in decades after the COVID-19 vaccination and $1.9tn in new stimulus, and market participants will be watching for clues that the Fed could start raising interest rates in 2023, sooner than it has previously indicated.
“It is no exaggeration to say that this FOMC meeting has the potential to be the most important in years, as markets are effectively demanding action from the Fed to counter the recent surge in bond yields,” said Tom Essaye, founder of Sevens Report, in a note.
Investors will also hear from Federal Reserve Chairman Jerome Powell, whose comments are likely to move stock and bond markets, although specifics are unlikely to be provided. Many expect the Fed chairman to stress the central bank’s willingness to allow inflation to rise above normal levels to ensure a full recovery in the Labour market.
“Some people think [Mr Powell] is going to be more dovish… With a new round of spending, it is hard not to sound dovish. They must be afraid of spooking the market. They’re worried about derailing the recovery, “said Peter Boockvar, chief investment officer at Bleakley Consulting Group.
The yield on the 10-year Treasury note rose 6 basis points to 1.683 per cent, hitting its highest level since early February 2020 and surpassing Friday’s recent high of 1.642 per cent. The yield on the 30-year Treasury bond jumped to 2.428%, its highest level since November 2019.
U.S. stocks fell on Wednesday as Treasury yields climbed. Higher interest rates erode the value of future cash flows, hurting growing companies in particular.
The Standard & Poor’s 500 Index fell 0.5 percent. The Nasdaq Composite Index fell 1.2 percent as technology stocks were hit again by rising bond yields. The Dow was up 80 points.
“In the absence of a clear commitment from the Fed that further rises in yields are unwelcome, yields could rise further and pull the dollar higher,” Commerzbank analyst Antje Praefcke wrote in a morning note.
She added that the euro/dollar could come under pressure in the short term as the European Central Bank has committed to accelerating the pace of its bond purchases to stem the rise in yields.
Gold edged lower, dragged down by rising Treasury yields and a stronger dollar, but remained in a tight range as the market awaited the outcome of the Fed’s monetary policy meeting.
Spot gold was trading slightly lower at $1,726.81 an ounce after more volatility during the session.
“Powell would probably say that inflationary pressures are likely to be transitory and not that great… That could push the 10-year Treasury yield higher and the dollar higher, and weigh on gold, “said David Madden, analyst at CMC Markets UK. He added that gold could fall towards $1,600 in the coming months.
But Madden said the Fed may also signal its intention to keep interest rates low to cushion gold’s decline and provide some support.
“Technically, a clear climb above $1,740 would provide room for further gains, while a break below $1,700 would signal weakness in gold,” said Carlo Alberto De Casa, chief analyst at Activtrades.