By Steve Englander, head of G10 FX and North America Macro Strategy at Standard Chartered
- The strong consensus is that policy rates move 50bps higher and QT is announced
- We see a hawkish stance as more likely than dovish at this meeting
- Widening the scope for 75bp hikes at future meetings or faster QT are the main hawkish risks
- Indicating satisfaction with market pricing would be seen as dovish
- Market fears may rise as FOMC approaches and unwind temporarily if the FOMC does just as expected
Hawkishness not yet interrupted
Money markets are pricing a c.52bps hike for the fed funds target rate on 4 May and 255bps by end-2022, near peak levels for both (Figure 1). To us this signals that 50bps is the base and 75bps a long shot possibility for this meeting. Some FOMC participants have signalled that 75bps moves are under consideration, but for future meetings beyond May. There is also a consensus that details on quantitative tightening (QT) will be announced with caps on balance sheet run-off quickly moving up to a total of about USD 100BN by late Q3 or early Q4. A Bloomberg survey suggests that most (like us) expect QT to begin mid-May.
As always, the market question is what can be hawkish or dovish versus these expected outcomes, and which side is more likely. Notwithstanding our expectation that the Fed hikes less than markets expect over 2022, we do not see much room for dovishness at the May meeting. It took a while for the FOMC to form a consensus and we don’t see an incentive for that consensus to break in H1. Monthly run rates for core PCE and average hourly earnings have come off their year-end peaks (Figure 2), but the levels remain too high and the drops too tentative for the FOMC to back off, in our view.
On the whole, we see a risk of hawkish fears continuing to build as the FOMC meeting approaches and maybe beyond. So expectations of Fed hikes could rise as we approach the FOMC meeting, putting pressure on asset prices and supporting the USD. If the FOMC sticks to the script and raises the policy rate by 50bps and announces QT – but no more – there may even be a brief relief rally. However, for a dovish rally to last, we think a clear turn in US economic data is needed, which has not yet happened.
The hawkishness can show itself in the statement with 'inflation pressures continue to rise substituting for 'inflation remains elevated as a nod to the risk of fed funds moving more than 50bps at future FOMC meetings. Or 'the Committee expects to begin reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities' could be replaced by the Committee expects to begin reducing its holdings of Treasury securities and agency debt and agency mortgage- backed securities, initially by run-off, starting in May'. Even if the statement text is little changed, Fed Chair Powell could convey similar sentiments at the press conference
FOMC statements so far have addressed neither what the level of neutral is nor the risk of and extent to which policy rates could exceed neutral. In the press conference, reference to the risk that estimates of neutral are rising or that policy rates could exceed neutral for a significant period or a significant amount would be viewed as ramping up the hawkish stance. In our view, much of the perception of increased hawkishness in recent weeks has come from the shift in Fed language across the hawkish/dovish spectrum from the need to get policy rates to neutral to the possible need to tighten beyond (with how much and how long unspecified).
We think the Fed at this point sees conveying a hawkish stance as more desirable than showing any wavering. The bar to added hawkish hints is largely that there is so much already on the plate for this meeting and so much uncertainty on forces beyond the Fed’s control economic spillovers from the COVID surge in China and the Russia-Ukraine war – that the FOMC may see it as prudent to go slow on further hawkish surprises at this point.
We don't think there is a major incentive to surprise on the dovish side at this meeting. The FOMC still characterizes the US economy as red hot'. We see signs of a slowdown (Figure 3), but we suspect the FOMC would want to see more evidence before backing off. Nonetheless, the most likely indications of dovishness would be a press conference comment that the market is pricing likely Fed policy adequately, which would be taken by market participants as a signal that the Fed has no desire to drive rates further up. Alternatively, some reference could be made to small indications that supply-chain issues (other than China) are beginning to resolve themselves. Given market positioning, any supply-chain optimism or suggestion that rates markets have enough hikes priced would be seen as dovish, but on balance extending the frontiers of Fed hawkishness seems more likely than pulling back.