Volatility heightens focus on Fed statement
IT’s that time again – when Wall Street traders turn into linguists, closely parsing the text of a Federal Reserve statement for minor word changes that could offer clues about the central bank’s future monetary policies.
Few people expect the central bank to raise its key policy rate above its current target of 2% to 2.25% when the Fed concludes its two-day meeting Thursday. There is also no press conference after the meeting, limiting officials’ ability to communicate their outlook.
Officials will, however, release a statement that analysts say could potentially tip in a dovish or a hawkish direction.
A glancing reference to recent market vol- atility or tightening financial conditions could be interpreted as a sign that officials are taking that volatility seriously, and proceeding cautiously about raising interest rates should it continue. At the same time, a reference to rising wages or other forms of inflation pressure could send the opposite signal: that officials are more concerned about inflation than skittish markets and are prepared to raise rates even faster than investors are anticipating.
Either move could send ripples through markets while many investors remain uncertain about the economic outlook. There is now little doubt the economy is doing well. The question is whether it is doing too well, with investors increasingly nervous that there could be an upswing in inflation or a hawkish turn by Fed officials intent on mitigating the inflation threat.
A big reason why US government bonds, and then US stocks, declined in recent months was rising uncertainty about inflation expectations and the Fed’s potential response, said Karissa McDonough, a fixed-income strategist at People’s United Wealth Management.
The conclusion of the US midterm elec- tions may have curbed some of that uncertainty, as analysts foresee slimmer odds that Congress could stoke the economy through additional fiscal stimulus. Yet much remains unknown, with recent data showing unemployment at a 49-year low and US workers earning their biggest pay raises in nearly a decade.
If Fed officials lean harder in a hawkish direction—suggesting they’ll keep raising rates to the point where it curtails economic activity – investors can expect more volatility, said Priya Misra, head of global rates strategy TD Securities in New York.