Fed could surprise markets and change investors' minds on how many rate hikes are coming

  • The Fed is likely to sound more hawkish — more prepared to raise interest rates — after its meeting ends Wednesday afternoon, and that could send a shudder through the markets.
  • Even though Fed officials are not scheduled to release a new interest rate forecast, they will have no choice but to admit that inflation is heading to a more normal level and the previous weakness was as they long suggested: "transitory."
  • The Federal Open Market Committee winds down its two-day meeting with a 2 p.m. ET statement. It is not expected to raise interest rates Wednesday, but it is expected to raise the fed funds target rate at its June meeting, when it will also issue a new forecast for interest rates and the economy.

The Fed is likely to sound more hawkish — more prepared to raise interest rates — after its meeting ends Wednesday afternoon, and that could send a shudder through the markets.

The Federal Open Market Committee winds down its two-day meeting with a 2 p.m. ET statement. It is not expected to raise interest rates Wednesday, but it could upgrade its view of both the economy and inflation in its post-meeting statement Wednesday.

Even though Fed officials are not scheduled to release a new interest rate forecast, they will have no choice but to admit that inflation is heading to a more normal level and the previous weakness was just as they long suggested: "transitory."

Federal Reserve Board Chairman Jerome Powell testifies before a Senate Banking Housing and Urban Affairs Committee hearing on the The Semiannual Monetary Policy Report to the Congress, on Capitol Hill in Washington, U.S., March 1, 2018.
Yuri Gripas | Reuters
Federal Reserve Board Chairman Jerome Powell testifies before a Senate Banking Housing and Urban Affairs Committee hearing on the The Semiannual Monetary Policy Report to the Congress, on Capitol Hill in Washington, U.S., March 1, 2018.

"They will be more hawkish. It's going to be a pretty bullish, hawkish statement — with a good economy and a warming trend. You had 1.9 percent in core PCE, the highest since January 2017," said Diane Swonk, chief economist at Grant Thornton. The PCE deflator, released Monday, showed that inflation picked up year-over-year in March, and the core number was just shy of the Fed's 2 percent target.

Markets could respond to a more "hawkish" Fed statement by sending Treasury yields higher, stocks lower, and the dollar could add to its recent gains. Market pros are fairly well split on whether there are three rate hikes or four coming this year, and if either group is persuaded of a new Fed stance, that could be a catalyst for a market move.

Treasury yields were higher in early trading Wednesday, with the Fed sensitive 2-year yield touching 2.52 percent. The dollar was higher in afternoon trading, after early weakness.

"I think you could see a little reaction. If the Fed validates the increased rate expectations we've seen that may be enough, with a dollar that is technically breaking out," said Robert Sinche, chief global strategist at Amherst Pierpont.

In the Fed's own forecast, Fed officials appear to be very close to being ready to agree to a fourth rate hike for this year. The Fed's "dot plot" presents Fed interest rate views in a chart with a dot for each anonymous Fed official's target. The Fed will release a new forecast at its June meeting.

"I think the risks are that markets interpret their commentary in a hawkish manner. I see risks pointing in that direction, as opposed to a dovish direction," said Mark Cabana, head of U.S. short rate strategy at Bank of America Merrill Lynch. Cabana said the Fed revealed in the minutes of its last meeting that officials were already moving closer together on inflation, and they now have a more balanced view.

"I think the risks are skewed that the Fed sounds more hawkish. The market will probably end up bumping its probability for a fourth rate hike," said Cabana, adding he currently expects just a total of three for this year. The Fed is next expected to raise its fed funds target rate in June.

Aaron Kohli, fixed-income strategist at BMO, expects a parade of Fed speakers at the end of the week to reinforce the Fed's hawkish tone.

"The Fed speak after the meeting is going to do a lot of the hawkish heavy lifting," said Kohli. "There's no dovish camp anymore." New York Fed President William Dudley and San Francisco Fed President John Williams, who will soon replace Dudley, both speak Friday. Fed Vice Chair Randy Quarles also speaks that day.