Can Fed Chair Jerome Powell slay the inflation monster? Here are 4 big things to expect from the central bank’s meeting this week

May 4, 2022, 11:30 AM UTC

All eyes are on Federal Reserve officials this week as they make a series of major policy announcements including their plans for raising interest rates.

Although the S&P 500 has posted its worst start to the year since 1932, Wall Street believes the central bank will implement one of the most aggressive interest rate hiking cycles in history as officials attempt to clamp down on four-decade high inflation without instigating a recession. 

Ensuring this so-called soft landing won’t be easy, however, as economic growth has already shown signs of faltering. In fact, some market experts argue that reducing sky-high inflation is impossible without some significant economic pain.

“The window for the Fed to engineer a soft landing has likely closed,” Danielle DiMartino Booth, CEO of independent research firm Quill Intelligence, told Fortune. “The economy is already starting to deteriorate before the bulk of the Fed’s inflation-fighting tightening actions have taken place. The last economic pillar standing is the job market, but we’re already seeing a weakening in new job postings and the beginnings of layoff announcements.”

If DiMartino Booth is right, the U.S. economy could be in for a rough ride. But either way, the Fed’s actions during this week’s meeting will be critical for both Wall Street and Main Street.

Here’s what to expect when the central bank reveals its decisions Wednesday afternoon.

The first half-point hike since 2000

The Federal Reserve is expected to announce a half-percentage point increase to the Federal funds rate as it attempts to cool rising consumer prices.

Market experts will be listening to whether the Fed’s tone is “dovish”—signaling a cautious path with fewer rate hikes ahead—or “hawkish,” which would demonstrate that officials are determined to keep raising rates to combat inflation, even if stocks take a hit as a result.

In March, the Fed opted for a quarter-point rate hike, striking a more hawkish tone than what was seen throughout the pandemic. The central bank’s officials argued Russia’s war in Ukraine and subsequent Western sanctions “are likely to create additional upward pressure on inflation and weigh on economic activity.” 

Now, with inflation rising at an 8.5% annual clip, experts would be surprised if the central bank fails to take an even more aggressive approach.

“The Fed has signaled a major hawkish shift, and we expect them to deliver,” Bank of America analysts, led by Alexander Lin, wrote in a Monday note, adding that they believe the Fed is all but guaranteed to hike rates by a half-point.

“The Fed would shock markets if it failed to deliver on more aggressive policy via a 50-basis-point rate hike on Wednesday,” DiMartino Booth said.

Federal Reserve balance sheet cuts

Since 2020, the Federal Reserve has increased the size of its balance sheet to nearly $9 trillion by buying mortgage-backed securities and U.S. Treasuries in hopes of spurring economic activity—part of a policy called Quantitative Easing (QE).

Now, market watchers are expecting a dramatic shift, with Fed officials turning to Quantitative Tightening (QT) to reduce liquidity in markets and combat inflation. 

Bill Adams, the chief economist for Comerica Bank, said he expects the Fed will allow about $32 billion in maturing bonds to be repaid in May, as the central bank increases its monthly balance sheet reduction limit to $95 billion by July or August.

“Surprises here are quite unlikely since the minutes of the Fed’s March meeting laid out general plans for the balance sheet reduction,” Adams added.

Some market experts fear the beginning of QT could hurt stocks, but there’s an element of mystery involved because of the unprecedented size of the Federal Reserve’s balance sheet.

“No investor nor anyone at the Federal Reserve knows how markets will react to reduced liquidity and quantitative tightening until the process actually begins,” DiMartino Booth said, noting that stocks did sell off “precipitously” during the previous era of QT at the end of 2018.

Economic growth and inflation predictions

The central bank will also reveal its so-called dot plot at its meeting this week, where each Fed official plots what they think the Federal funds rate will be over the near, medium, and long term.

It’s a part of the central bank’s Summary of Economic Projections (SEP) that also includes rough estimates from officials for unemployment, gross domestic product, and inflation.

The dot plot helps markets determine just how aggressive the Fed will be in raising rates, and most Wall Street experts, including UBS analysts led by Jonathan Pingle, expect Fed officials to show a hawkish streak on Wednesday.

The UBS team wrote in an April 25 note that they expect Federal Reserve officials to emphasize at this week’s meeting that their “main goal” is reducing inflation to 2%.

However, the analysts added that “more neutral” wording from Fed Chair Jerome Powell during his prepared remarks is also likely as central bank officials look to avoid panicking investors.

Guidance on the pace of rate hikes moving forward

Bank of America analysts said they expect the market’s attention to be squarely focused on the Federal Reserve’s guidance on Wednesday. In particular, the bank is looking at how Powell handles questions about the possibility of a 75-basis-point hike to the Federal funds rate in June.

“We expect Powell to be non-committal on a 75bp rate hike: neither supporting nor dismissing the possibility,” the analysts wrote. “When Powell is faced with the question, we expect a similar answer to the March press conference which said decisions will be made meeting by meeting.”

Powell’s Wednesday press conference will be critical for market watchers, experts say. In a Monday note, Morgan Stanley analysts led by Ellen Zentner, said they also believe the Fed will strike a hawkish tone, and that Powell will keep his options open for the June meeting.

It’s a view that’s widely shared by economists and market experts. 

“I expect the Fed to signal another half percentage point hike is likely at their next decision in June, and that additional hikes—probably no specifics on the number or magnitude—are coming in the second half of the year,” Comerica’s Adams said.

Adams added that he believes the Fed will emphasize that “they don’t have a crystal ball” and can’t know the outcome of the ongoing lockdowns in China or the war in Ukraine, both of which have put a drag on the global economy.

“The Fed can only watch and react. If the negative effects of these shocks fade gradually, as Comerica’s forecast assumes, growth and inflation will both start to slow by the late summer or early fall, and the Fed’s pace of rate hikes also will slow in the second half of 2022,” Adams explained.

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