Call it the “Clash on Constitution Avenue.”
The Federal Reserve insists rates will rise above 5% and stay there for some time. Money markets see the Fed struggling to get rates above 5% and have priced in cuts by year-end, a view that has helped fuel a tech- and growth-led rally for stocks to begin 2023.
Read: The Fed and the stock market are on a collision course this week. What’s at stake.
That’s led to expectations that Chair Jerome Powell will use his news conference to forcefully push back against expectations for cuts this year, emphasizing that rates need to say elevated and that the inflation battle is far from over.
Related: 4 ways Powell could tell markets the Fed isn’t ready to pivot
Powell and the Fed may also take aim at easier financial conditions, as represented in part by tightening credit spreads, rising stocks and a weaker dollar, which are seen working at cross purposes to the Fed’s tightening of monetary policy.
See: The Fed delivered a message to the stock market: Big rallies will prolong pain
But Powell might need to avoid any nuance if he wants to drive home the idea that rates will remain higher for longer, economists and analysts said.
“We have been on the road a ton over recent weeks, and we feel very comfortable saying that in our sample the skew is clearly toward the market wanting to hear something dovish,” said Tom Porcelli, chief U.S. economist at RBC Capital Markets. “And when you have a bias, you are very likely to hear what you want. A little selective hearing is likely to go a long way.”
“Dovish” is market lingo for a central banker more concerned about growth than inflation.
Treasurys rallied in January, dragging down yields, which aided the stock market rally, particularly for previously beaten down tech and growth stocks that led the equity plunge in 2022. Positioning data, meanwhile, shows speculators have built up large short positions on bets yields, which move opposite to debt prices, will likely rise if the Fed and Powell deliver a hawkish, or tough on inflation, message, said Ian Lyngen and Benjamin Jeffery, rates strategists at BMO Capital Markets, in a note.
“From the perspective of both positioning and the Fed signaling prior to the premeeting radio silence, there is a clear bias for U.S. rates to end higher on Wednesday as a result of a steadfastly hawkish Committee,” they wrote.
The rub is that the “pain trade” — a term that refers to the market’s tendency to punish herd-like behavior by investors from time to time — would be for a continued Treasury rally and a fall in yields.
“As a result, we’ll be wary of a potential bias to interpret any headline that isn’t unabashedly hawkish as a flaw in the armor of Fed resolve,” the strategists wrote. “Said differently, the bar is extremely high for Powell to surprise on the hawkish side and therefore it’s much more likely that Powell is read as ‘hawkish lite’ — triggering short-covering and a curve steepening.”
Others argued it may come down to just how consistent Powell is in delivering a stern message about the Fed’s resolve to keep rates elevated.
“If Powell explicitly says the market is wrong (or something to that effect) and is forceful and hits that idea over and over, that will be taken as hawkish,” said Tom Essaye, founder of Sevens Report Research, in a note.
“If he largely dismisses that and doesn’t take the opportunity to essentially “brow beat’ markets about this expectation, it’ll be taken as dovish (and stocks will rally),” he wrote.
The Federal Reserve is seen as virtually certain to raise the fed-funds rate by 25 basis points, or a quarter of a percentage point, to 4.5% to 4.75%. The Fed’s policy statement is due at 2 p.m. Eastern, with Powell to begin his news conference at 2:30 p.m.
Read: Fed set to deliver quarter-point rate hike along with ‘one last hawkish sting in the tail’
Stocks were trading lower at midday Wednesday, with the Dow Jones Industrial Average
down 340 points, or 1%, while the S&P 500
shed 0.5% and the Nasdaq Composite
dipped 0.3%. All three indexes rallied last month, with the Nasdaq’s 10%-plus rise marking its best January since a bear-market bounce in 2001.
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