Market Insider

Why the Fed meeting could create fireworks

Market expectations vs Fed

The Fed meets Tuesday and is widely expected to signal an end to the era of near zero interest rates, for the first time in more than six years.

The two-day meeting ends Wednesday, and the market expects the central bank to drop the word "patience" from its statement, a sign that it could start raising rates as early as June. It will also release economic forecasts, and Fed Chair Janet Yellen will hold a briefing at 2:30 p.m. EDT.

But it's the nuances in the Fed's forecasts that may provide hints on timing and the speed of rate hikes. These signals could also prove to be market moving, if the central bank makes any changes that hint at a faster rate hike cycle or a very slow course.

Traders work the floor of the New York Stock Exchange.
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Jeff Rosenberg, BlackRock chief investment strategist for fixed income, says markets are watching guidance from the Fed on the long-term unemployment rate and inflation. Those represent the Fed's dual mandates, and a change in either could affect the pace of rate hikes.

If inflation expectations are lowered for instance, the Fed could move at a slower pace to carry out future rate hikes.

By dropping "patience," the central bank is expected to emphasize that it is data dependent. While many economists expect the language to be changed, their views differ on whether the Fed will move forward with its first rate hike in June, September or even later.

Markets have also been highly volatile in the days leading up to the Fed meeting. The stock market in recent sessions has been dancing to the tune of the rising dollar. After Friday's big selloff, the Dow on Monday jumped 228 to 17,977 and the S&P 500 soared nearly 1.4 percent to 2,081. Bond yields moved lower, as traders bought Treasurys ahead of the Fed meeting.

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The central bank will also provide interest rate forecasts with its projections. The forecasts are presented as a series of dots on a chart representing individual Fed official's views. The chart currently shows expectations of a hike in the fed funds rate at a middle range of about 1.125 percent.

George Goncalves, head of rates strategy at Nomura, believes the Fed may have been too aggressive with its previous rate rise forecast. He expects the first hike in September.

"They need to lower the dots if they believe they're going to hit their growth targets," he said. According to the projections, Fed officials expect to see GDP at 2.6 to 3.0 percent this year and 2.5 to 3.0 percent next year. "They only way they're going to achieve their optimistic outlook for inflation bouncing back and growth turning the corner is if they don't hike so much."

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Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi, said he's watching the Fed's interest rate projections for any changes before the end of the year. The last time the central bank released forecasts was in December.

"We've had three gigantic jobs reports since then so if anything you'd think they would move up the timetable," he said.

Goncalves said while unlikely, it would be viewed as dovish if the Fed surprised the street and left in the word "patience."

"People are going to probably end up walking out of this more impressed by the press conference, especially if she talks about the dollar," said Goncalves. "Otherwise, it's pretty overanalyzed." He said the Fed is looking for flexibility so that it can assess the economic data in April, May and June.

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Yet, some in the markets are watching for waves after the Fed meeting, given recent volatility.

"If you look at positioning, people got short the front end ... expecting a big Fed move this week," Goncalves said.