The Fed has to walk a fine line Wednesday as financial markets hang in the balance

A recovering economy, persistent inflation and a stock market tearing higher do not seem to make much of a recipe for monetary policy easy.

But that is the situation in which the Federal Reserve finds itself.

The challenge for the central bank this week is to explain that situation to investors and reassure them that even if the status quo remains, that will not force policymakers to change course, and they should not.

“The bottom line is, ‘Everything looks a little better, but there’s still a lot of uncertainty and we won’t be doing anything any time soon.’ I’m sure we’ll hear that, “said Bill English, former head of Fed’s Department of Monetary Affairs and now professor of finance at Yale Management School.

“They want to suggest that things are better,” he said. “On the other hand, they don’t want to say they’re going to change policy anytime soon. So it’s a difficult communication.”

The Federal Open Market Committee, which sets monetary policy, meets Tuesday and Wednesday, followed by a press conference from Fed Chairman Jerome Powell.

No one expects far-reaching changes. Short-term lending rates remain close to zero, and the Fed will continue to buy at least $ 120 billion a month in bonds to keep markets flowing and the financial situation loose.

There will be a lot for investors to chew from this meeting.

For one, individual members will update their projections for gross domestic product, unemployment and inflation.

They finally submitted estimates in December, before Congress approved two nearly $ 3 trillion incentive packages and before the Covid-19 vaccine was released that sees 2.4 million Americans receive into every day.

Goldman Sachs recently raised its GDP forecast to 7% for the full year and is also seeing unemployment fall faster than expected as inflationary pressures warm up.

In contrast, the Fed’s Economic Forecasts Summary in December showed a median estimate of just 4.2% for GDP, along with an unemployment rate forecast of 5% and underlying inflation running around 1.8%.

These numbers are likely to see “substantial upward revisions,” according to Bank of America.

The GDP figure could be raised by “at least” 1.5 percentage points to a range of 5.7% to 6%, while unemployment could fall to 4.8% and inflation rise to a target 2% at the Fed, according to Bank of America.

Inflation has already been a headache for the Fed, with bond yields rising and market prices rising, by one measure, to their highest level in nearly 13 years.

The bank’s economic team said in a note that this week’s meeting called “one of the most crucial events for the Fed in time.”

Powell needs to “strike the right balance” between the Fed’s optimistic and willing economic outlook allowing inflation to run warmer than normal in an effort to ensure broad and inclusive employment benefits from income, race and income. gender, Bank of America. fa-near.

Powell was able to use the event to drive gradual policy changes.

“This may be the Fed’s first step in the less relevant direction as they move to set the stage for a taper policy & finally tighten,” the bank’s note said.

In the past few weeks, markets have been claiming that the Fed would change bond purchases to bring down further rates that have jumped to pre-pandemic levels this year and beyond. caused volatility in the stock market.

Powell has pushed back on that idea.

Investors, through the dot Fed plot of individual member expectations, will get an insight into the extent of the consensus for an unchanged approach.

“Everyone seems to be on board with the new framework, but it may not mean the same thing to everyone,” said Tom Graff, head of revenues at Brown Advisory . “That probably doesn’t mean [some members] they’re so hawkish that they just see this average inflation targeting regime working differently than Powell could. “

The market could, therefore, leave to determine which policy “dots” are moving towards raising rates. The market is already priced in potential to rise in late 2022 and triple in total by the end of 2023, according to Citigroup. Current Fed estimates are not for trends to 2024 anyway.

“It’s going to be interesting, because how do you update your GDP projections to 7% and your inflation target to 2% and your unemployment forecast to 5% and then say that we’ll be very easy, “said Kathy Jones, Charles Schwab ‘s main revenue strategy based.” Patience is what they try to emphasize. “

Jones said she does not yet expect a policy shift, with Powell stressing the importance of “such a widespread and inclusive rise in employment and a reduction in unemployment before they even consider raising rates.”

“They are very comfortable waiting for him,” she said.

English, the former Fed official and Yale professor, said Powell would stress “uncertainty” despite progress with the virus and the economy.

“Part of the communication is that our response action has not changed. We still want to achieve our goals, we still have to be patient,” “he said.” The most likely outlook is better, but the world is a place of uncertainty. A lot can happen. “