What the Fed Will Do—and Why

The big economic story today will be the end of the regular meeting of the Fed and what it decides to do about interest rates. Markets are expecting a 25 bp increase, to a range of 5 percent to 5.25 percent, with a slight bet on no hike at all. This is the baseline that the commentariat will be reacting to once the news comes out this afternoon. 

I agree that a 25 bp hike is the likely outcome, to the point that anything else would be a bit of a shock and generate a market reaction. In fact, that reaction is one of the reasons that hike is so likely. But because of that, for this meeting especially, it is important to look beyond the numbers (as we do) and think about what that 25 bp hike means in the broader context. 

Consider the Variables

As usual, the two variables the Fed is looking at are employment and inflation. For employment, we have seen a slowdown, but the numbers are still quite strong despite that. This means the Fed’s job isn’t done there. For inflation, with wage growth and spending still growing, the recent declines are good news. Again, the data is saying the Fed isn’t done yet. Both of these variables suggest more rate hikes are ahead. Other metrics say the same. 

But markets are counting on a much more dovish approach. There is, as I noted, a small chance priced in that we don’t get a rate hike at all today. Markets are pricing rate cuts soon. And most of the commentary I see is saying the same thing. Which is why the important news today won’t come from the Fed’s statement (regardless of the 25 bp hike) but from the press conference. Once again, Chair Powell is going to hold center stage. 

Watch Powell’s Commentary

Once he is there, he will do the usual duck and weave. “Data dependent” may well appear, along with comments about how policy will keep focusing on inflation. What I will be watching for is the following. 

First, what does he talk about? If he stays focused on inflation, then more rate hikes are in play, as inflation remains the primary concern. If he talks about the slowing economy, especially in terms that suggest the Fed is starting to worry about it, a pause is more likely. 

The reason this matters is that there is apparently a debate within the Fed over when the effects of past rate hikes will show up in the economy. We have seen some slowing. As the prior hikes keep weighing on growth, that slowing should get worse—an argument for a pause. 

The same analysis applies to the recent banking system problems. With the shutdown of Silicon Valley Bank and First Republic, as well as the recent collapse in the share prices of other regional banks, the banking system will clearly be pulling back on lending, which should slow growth further. And that hasn’t even really gotten started. If Powell starts talking about this at any length, that too will be an argument for a pause. 

Where Is the Puck Going?

In other words, I don’t expect any real news from Powell about what the Fed will do. But what he is asked about and chooses to talk about will speak volumes. If he stays focused on inflation, that is hawkish. If he talks about a slowing economy and the banking system, it will be dovish. We don’t know what the Fed will do, and, honestly, neither does the Fed at the moment. But we can know what the Fed is focused on. 

Don’t look at the puck. Look at where Powell thinks the puck is going.