The Federal Reserve is unlikely to take any policy action after its two-day meeting this week, but it will likely signal that it is considering it.

Some economists expect the Fed to announce an impending tapering of its bond-buying program and to provide preliminary guidance for the discussion, but has not yet fully committed itself to a tapering. The Fed will also publish new economic forecasts every quarter.

There’s a chance it could see an initial rate hike in 2023. In his previous forecast, there was no consensus among Fed officials about a rate hike through 2023.

“I think the commentary and the press conference will be interesting. There is clearly a split on the board of directors and among Fed presidents over how strong the economy is and whether it is time to move forward with policy, ”said Rick Rieder, BlackRock’s chief investment officer, global fixed income. “How the chairman describes it is going to be very interesting. It’s hard to say that it is [going to be] hawkish because … I think it’s going from overly reticent to overly reticent. “

The Fed’s two-day meeting ends on Wednesday afternoon with the release of its usual position paper and quarterly forecasts. Fed Chairman Jerome Powell will then hold a press conference.

Federal Reserve Chairman Jerome Powell speaks to reporters after the Federal Reserve cut interest rates in an emergency move to protect the world’s largest economy from the effects of the coronavirus during a news conference in Washington on March 3, 2020 .

Kevin Lamarque | Reuters

Taper conversation

At their last meeting, some Fed officials noted that according to the minutes of the meeting, it may be appropriate to discuss a plan to adjust the pace of bond purchases as the economy moves forward.

That discussion could start this week, but only on a preliminary level, say some economists. The real details on reducing its $ 120 billion monthly purchases are slated to be revealed later this year. Many economists expect the official discussion to take place in late August, when the Fed holds its annual symposium in Jackson Hole, Wyoming. The Fed could then begin winding up its bond purchases at the end of this year or early next, they say.

“This week’s message is likely to be a large dose of ‘still a long way to go’, riddled with worries about upside inflation risks. We don’t expect the tapering debate to be robust, but simply start the discussion and express concerns the strong inflationary impulse should have a restrictive undertone, “said Barclays economists in a press release.

The tapering of the bond program is important because at the beginning of the end of its so-called quantitative easing, the Fed would be well on its way to eventually tightening policies – or raising rates. The Fed began buying government bonds and mortgages last year to provide liquidity if the Covid pandemic stalled the economy.

Once the Fed begins tapering purchases, it could take months to complete. When it hits zero, the door would be open for the Fed to hike rates. The Fed’s loose policy is credited with fueling the stock market rally to repeated new highs and creating a robust environment for the real estate market.

“Start Talking About It”

Powell could choose to bring up tapering during his post-meeting press conference and he will surely be asked about it.

“We don’t expect any major policy changes from the Fed. Most of this will be characterizations of tapering and what the Fed says about it, along with adjustments to the Fed’s forecast,” said Mark Cabana, head of US Short Rate Strategy at Bank America . “We think they’ll start talking about it. We expect Powell to repeat that it will be some time yet.”

However, Goldman Sachs economists say it is too early for the Fed to “talk about a cut,” although some Fed officials would like to begin the process. Officials at the core of the Fed – Governor Lael Brainard and New York Fed President John Williams – are not doing this.

“We think Powell is likely to agree with Governor Brainard and President Williams that the job market is not advanced enough. We still expect the first notice in August or September, followed by a formal announcement in December and the start of the reduction early next year, “Goldman economists said in a statement.

Hot inflation

The Fed is expected to raise its inflation forecast for this year after reading hotter than expected this month and last. The consumer price index for May rose 5%. Economists are focusing on the 2023 forecast, as higher inflation in the future could cause the Fed to revise its interest rate forecast as well.

The Fed is monitoring core consumer spending inflation. The most heavily observed inflation forecasts are those for 2023, as the Fed would then expect a rate hike if inflation persists. The Fed has so far stated that the rise in inflation is temporary and is due to disrupted supply chains and a backlog.

“It could become increasingly difficult for Powell to fire [inflation] as expected, “said Cabana.” He’ll probably say, ‘We’re monitoring it. … We still believe it will be temporary, but we will monitor the data very closely. ‘”

Cabana expects rising growth and inflation forecasts for this year and next. Fed officials currently expect core PCE inflation to be 2% in 2022 and 2.1% in 2023.

“How much leakage by 2023 will the real statement be. Are any of these inflationary pressures lasting? Do they last a few years? Probably not, but we’ll see,” he said. “Will the Fed initiate a rate hike in 2023 or not? It only takes three Fed officials to switch to the rate hike camp to see this. We think it’s close, but they probably won’t switch. “

The Fed presents its inflation forecast in a “dot plot” with anonymous entries for each Fed official. In March, the dot plot showed an 11-to-7 split versus an increase in 2023. JPMorgan economists expect several Fed officials to change their positions and support an increase in 2023. They also changed their own rate forecast to a rate hike in 2023.

However, Bank of America strategists don’t expect officials to agree on an increase in 2023. “We think they will stay on hold, but that will be one of the focal points of the market,” said Cabana. “The market is pricing in 2.2.5 hikes by the end of 2023. The Fed does not currently expect any.”

Overnight rate

Fed observers are also divided on whether the central bank will make technical adjustments to some short-term interest rates.

Cabana expects the Fed to raise excess reserve rates slightly due to mounting pressures in the short-term credit market.

Tax incentives have resulted in a large amount of money ending up in the Treasury’s main account, basically the Treasury’s checking account. As the funds leave the Treasury Department to pay for programs, they have found their way into the money markets and banking system, creating tremendous demand for short-term paper.

This has resulted in unusually high activity in the overnight loan market and lowered Treasury bill interest rates.

“With regard to the IOER and Overnight Reverse Repo Facility, we assume that they will adjust the setting of these rates slightly. [by] 2 or 3 basis points. This is done to increase the resilience of the [the Fed’s] Zero interest rates and keep money market funds from going negative, “Cabana said.” There really is too much cash in the banking system. The banks don’t want that. They’re pushing money market funds … and money funds are telling us they don’t either. The T-bill rates are zero. … They all hope for an adaptation like this meeting. “