Federal Open Market Committee meetings are usually staid affairs, featuring informed and measured discourse that only highly trained capital markets professionals, academics and a handful of policymakers can truly understand.
Its meeting on Tuesday and Wednesday, though, will be anything but that.
While the FOMC is expected to keep its policy rate between a range of 3.5% and 3.75%, the real action will be at the news conference afterward on Wednesday, when Federal Reserve Chair Jerome Powell will face reporters.
Powell will face questions about the White House’s recent pressure on the central bank, including the announcement that Powell was under criminal investigation by the Justice Department, and the administration’s efforts to remove a Federal Reserve governor, Lisa Cook.
We expect that Powell will use his platform to provide an erudite but accessible defense of central bank independence—not unlike his two-minute video statement on Jan. 11 that followed the Justice Department’s announcement of the criminal inquiry.
“The threat of criminal charges is a consequence of the Federal Reserve setting interest rates based on our best assessment of what will serve the public, rather than following the preferences of the President,” he said. His remarks were a striking departure from his customarily measured responses to the administration’s efforts to influence the Fed.
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The discussion around central bank independence will suck all the air out of the room and will most likely see a real-time response out of the White House.
“This is about whether the Fed will be able to continue to set interest rates based on evidence and economic conditions—or whether instead monetary policy will be directed by political pressure or intimidation,” he said.
Powell, whose term ends in May, also showed no signs of backing down.
“Public service sometimes requires standing firm in the face of threats,” he said. “I will continue to do the job the Senate confirmed me to do, with integrity and a commitment to serving the American people.”
These remarks are what professional investors across asset classes will focus on.
Given the volatility in the bond market following the repricing of geopolitical risk because of tensions over Greenland as well as the recent six standard-deviation move in long-term Japanese bond yields amid political tensions in Japan, what Powell says will be a big money, high stakes event.
The FOMC statement
We expect the FOMC statement to remain largely unchanged from its December statement except for the inflation paragraph.
The phrase, “Inflation has moved up since earlier in the year and remains somewhat elevated,” will most likely be replaced with something like “inflation growth has eased but remains elevated.”
The Summary of Economic Projections, which is released four times a year, will not be published on Wednesday. The next one will be released in March.
The market
As of Friday, both federal funds futures and overnight index swaps imply no rate change at this meeting. In fact, investors are now pricing in only a 45.2% probability of a rate cut at the June meeting, which would be presumably the first appearance of a new Fed chair.
Our estimate for the neutral rate is 3.5%, which is higher than the Fed’s estimate of 3%.
Indeed, our look at U.S. financial conditions stands near one standard deviation above neutral, which implies a tailwind behind domestic growth.
Our models
We use four models to estimate the optimal policy rate for the United States. None implies a rate cut anytime soon. Our preferred model using the personal consumption expenditures index implies that the Fed, by pushing the policy rate to a range between 3.5% and 3.75%, stands roughly 75 to 100 basis points below the optimal rate, which denotes risk of a policy stance that is too accommodative.
The best long-run predictor of inflation is the core PCE rate. Using that as one of the primary policy variables in the model yields a policy rate that also stands 75 to 100 basis points below the optimal rate.
Given that the December consumer and producer price indexes have been released, we can estimate the December PCE inflation rate. Our estimate points to an increase to 3% in both the top-line and core metrics, which strongly suggests that the bar on any rate cut is higher than commonly acknowledged.
In addition, with expansionary fiscal policies likely to fuel robust growth this year, the idea of a rate cut is growing increasingly remote. Strong growth will only exacerbate the tensions between the Fed and the White House.
The takeaway
Get the popcorn ready because we think this will be an FOMC meeting unlike any other during the Powell era at the Fed.
Powell’s public appearance at the Supreme Court in support of Cook, the FOMC governor, can reasonably lead one to anticipate that he will emphasize the importance of central bank independence in setting monetary policy, preserving the Fed’s credibility, and managing the economy.
This news conference, following a tumultuous two weeks, will be the next step in defining Powell’s legacy.
