What to watch for when the Fed meets Wednesday

Federal Reserve Chairman Jerome Powell must thread the needle in the coming days.

On the one hand, the economy seems to be stumbling as the year draws to a close given the alarming spread of the coronavirus across the entire country.

On the other, economic activity is expected to recover sometime next spring or summer as COVID-19 vaccines become widely available.

Should the Fed take any more action to help the economy bridge the pandemic? Or is the best bet waiting for more economic relief from Congress? Washington lawmakers seem tantalizingly close to a deal by the end of the week, yet it could be another false dawn for a fifth round of COVID-19 fiscal relief.

Despite the twists and turns of the soap opera centered on COVID spending, financial market conditions have remained healthy all summer and fall, helped in large measure by the Fed’s purchases of $80 billion of Treasurys and $40 billion of mortgage-debt each month.

Yields on the 10-year Treasury note
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0.895%

have remained range bound under 1% even as equity markets have soared on belief that Fed policy will remain easy.

The central bank will issue an updated policy statement along with new economic projections at 2 p.m. Eastern. Powell will follow with a news a half-hour later.

There is no consensus view among economists about what decisions Powell will take at this week’s meeting.

“That there will be no change in the Fed funds rate target range is the only thing about this week’s FOMC meeting that seems certain. Beyond that, every facet of the meeting, starting with the post-meeting policy statement and ending with Chairman Powell’s post-meeting press conference, comes with questions,” said Richard Moody, chief economist at Regions Financial Corp.

Here’s a look at what economists and investors will be watching for when the Fed concludes the two-day meeting on Wednesday.

Guidance on bond buying

According to the minutes of their last meeting in early November, Fed officials had a lengthy discussion about giving the market more information on how long it would keep up its $120 billion per-month bond buying plan and what it might buy.

At the moment, the Fed said it would keep asset purchases “at least at the current pace” to sustain smooth market functioning and help foster accommodative financial conditions. All the Fed has said is that it expects to slowly end or “taper” the purchases “sometime before the FOMC would begin to raise the target range for the federal funds rate.”

Michelle Meyer, chief U.S. economist at Bank of America Merrill Lynch, thinks the Fed will say it plans to continue its asset purchases “until sufficient progress has been made to ensure that inflation, over the longer run is at a rate of 2%.”

Krishna Guha, thinks the Fed language will aim to guide the market not to expect tapering before the end of 2021.

Other economists see the wisdom in putting this question off until next year.

“Right now, the emphasis is on “we’re going to keep going at least at this pace until and that until is going to be a pretty long distance from where we are,” said Julia Coronado, president of MacroPolicy Perspectives.

The Fed doesn’t want to send any message that “look out here comes tapering,” she added.

Changing bond-buying to buy more longer-dated paper

Some economists think the Fed will tweak its bond buying operations this week to buy more longer-dated Treasury bonds.

Kathy Bostjancic, chief U.S. financial economist at Oxford Economics, thinks the Fed will want to push back on market expectations for a “gradual reflation story” taking hold in the market and steepening the yield curve in 2021.

Read: Wall Street forecasters focus on ‘gradual reflation story’ for 2021

“The Fed will follow through to avoid an unwanted spike in long-term borrowing rates that could partially offset the impact of prospective fiscal stimulus and lead to an undesired tightening in financial conditions,” Bostjancic said in a note to clients.

The Dots: When will inflation reach 2% target?

Economists will be watching closely for any changes to Fed view on when its benchmark policy rate might rise off zero.

In September, the Fed said it didn’t expect rates to rise until after the end of 2023. Only four of the 17 officials projected the benchmark rate to rise in 2023.

“We wouldn’t be surprised to see of that number is larger in the updated dot plot, even if the median dot continues to imply no rate hikes,” said Moody of Regions Financial.

The Fed has penciled in above-target 2% inflation, notes the economics team at Bank of America Merrill Lynch. That is because the market cuts through the Fed talk and senses that once inflation gets to 2%, presumably rate hikes will follow. In September, the Fed didn’t see inflation at 2% until 2023. The market has priced in the first rate increase later that year, according to BofA economists.

Economists will be watching closely for any changes to Fed view on when its benchmark policy rate might rise off zero.

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