Fed Chairman Powell's first meeting could bring on more market volatility

  • Fed Chairman Jerome Powell's first meeting is likely to come off as hawkish after the Fed raises rates and releases new forecasts for the economy and interest rates.
  • But widely diverging views on what the Fed might say about future rate hikes could result in market volatility regardless of what it forecasts.
  • Treasury yields rose ahead of the Fed this week, and investors sold interest-sensitive stocks Tuesday in anticipation of more rate hikes.
Federal Reserve Board Chairman Jerome Powell testifies before the House Financial Services Committee in the Rayburn House Office Building on Capitol Hill February 27, 2018 in Washington, DC.
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Federal Reserve Board Chairman Jerome Powell testifies before the House Financial Services Committee in the Rayburn House Office Building on Capitol Hill February 27, 2018 in Washington, DC.

Fed officials are expected to raise interest rates Wednesday, but it's not clear they will do much to resolve the debate in markets about how many more hikes are coming this year or next.

The Fed has forecast three hikes for this year, but some economists expect it to add another. The market has priced in three hikes, but the question is whether Federal Reserve officials will signal a fourth when they release their latest forecasts Wednesday afternoon. That could result in a jump in bond yields and a stock market sell-off.

The Fed is expected to release its statement and forecasts at 2 p.m. as usual, even though government offices are mostly closed due to a major snowstorm.

One thing the markets do seem to agree on is that the tone of Fed Chairman Jerome Powell's first meeting will be decidedly hawkish, and the Fed will reinforce that it sees an improved economy and it plans to continue raising interest rates.

Treasury yields rose Tuesday in anticipation of Fed rate hikes and were higher again Wednesday, with the 2-year yield reaching 2.35 percent, a near 10-year high. Stocks traded higher Tuesday, but there were undercurrents that suggested the market was also setting up for rate hikes, as real estate, telecom and utilities shares slumped and financial stocks rose.

"The laggards are the interest-rate-sensitive ... telecom, real estate, which would indicate in some ways folks are hedging for the potential for that fourth rate hike being signaled tomorrow. I think folks are still unsure," said Michael Arone, chief investment strategist at State Street Global Advisors. "It looks like the equity market could still be hedging for that result."

The Fed is expected to notch up the target fed funds rate range by a quarter point to 1.25 to 1.50 percent, and also provide new forecasts for the economy and interest rates. The latter has been the topic of market speculation for weeks.

Fed officials present their forecasts in a so-called dot plot, a chart that includes anonymous entries from each official on the course of interest rates.

"I don't think they want to sound outright hawkish, but I do think they want to signal increased optimism about the outlook, and we think that will manifest itself through increased expectations in the dots," or interest rate forecasts, said Mark Cabana, head of U.S. short rate strategy at Bank of America Merrill Lynch.

"We don't think they'll adjust 2018," he said, adding there could be moves up in the two following years as well as a higher longer run rate of 2.875 percent, up from 2.75 percent.

Diverging views in the markets may result in a volatile reaction, no matter what the Fed does. Many economists agree with BofAML and expect the Fed to stick with its forecast for three rate hikes this year, including the one Wednesday. But others see a chance for four this year and one or two more added next year.

"I think with the strength of the data coming out and more people re-evaluating the implications of the fiscal package a lot of people are upgrading their views on the U.S. economy," said Dave Leduc, CIO, active fixed income at BNY Mellon Asset Management North America, who is forecasting four. "The belief is the fiscal package will help the Fed normalize policy."

Some market pros said if the Fed does move its longer run rate, the point where the Fed is expected to stop raising rates, that would surprise the market and cause bond yields to rise. As it is, bond yields have been rising this week, with the 2-year Treasury yield touching 2.35 percent, a new nine-year high.

"There are a number of risks at this meeting that investors are underestimating," said Arone. "If you think of Powell's firsts, a few have been characterized by volatility. The week he was sworn in, we had a market correction. He used the congressional testimony to speak effusively about economic growth, and people became concerned about that fourth rate hike."

Arone said Powell's first press conference Wednesday after the meeting could result in similar volatility. "He could signal more rate hikes," he said. He said the Fed's forecasts are also a risk, though he does not expect more than three rate hikes for 2018. He sees another added to 2019.

There has been speculation Powell could announce that the Fed would hold a press briefing after every meeting instead of just once a quarter. That could be taken as a hawkish signal to the markets that the Fed wants flexibility to raise interest rates more often.

Powell could also be put in the position of responding to questions about fiscal policy, such as the deficit spending aspect of the tax cuts. "Powell is definitely going to get asked about the trade situation in the post-meeting press conference. Those things could lead to more fireworks than people are expecting," Arone said.