Federal Reserve

Can the Fed see eye to eye with markets?: Expert

Wide gap between market & the Fed

While some market watchers may have wanted a more hawkish Fed who clearly pronounced the monetary path for the remainder of the year, the Fed wouldn't be willing to give insight beyond March's meeting, chief U.S. economist at Morgan Stanley, Ellen Zentner, told CNBC.

"Markets are just not going to get that," she said in an interview with "Power Lunch" Wednesday. "Not from a data dependent Fed that does no forward guidance."

As investors awaited Fed Chair Janet Yellen's testimony before Congress, the Street talked about the possibility of a negative interest rates policy. The conversation was mostly sparked by the Federal Reserve's 2016 stress test cycle requirements.

This year's scenario requires participating banks to factor in "a severe global recession in which the U.S. unemployment rate rises 5 percentage points to 10 percent, accompanied by a heightened period of corporate financial stress and negative yields for short-term U.S. Treasury securities."

Recently, Japan adopted a negative interest rate policy. This has fueled worries that negative rates could be implemented in the U.S.

Yellen, however, said that while she is "not aware of anything that would prevent us from doing it … we have not fully investigated legal issues; that still needs to be done."

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Federal Reserve chair Janet Yellen testifies before the House Financial Services Committee on Capitol Hill in Washington, DC, on February 10, 2016.
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Market watchers have also debated of the implications of a policy reversal from the committee, and for some that would raise questions about Yellen's credibility. Market volatility has also caused investors to consider whether rates hikes are ideal for the current market climate. Still, Yellen said on Wednesday that she doesn't "think it's going to be necessary to cut rates; that said monetary policy is not on a preset course."

The gap between the Fed and the market's perspective has remained wide.

"The Fed is never going to see eye to eye with the markets," Zentner said." She also expressed that market sentiment has "gotten disconnected from the fundamentals of the economy."

The chief economist considers that the market is pricing in a recession and the committee is "going to have to" revise its forecast of growth and inflation in its March meeting. For the Fed to bridge the gap with the market, it is going to have to lower the Fed dot plot from four to two, she said.

"That's not that far from market perception," she added.