Market Insider

Here are the three big changes the stock market is hoping to see from the Fed

Key Points
  • The Fed is expected to raise interest rates by a quarter point, but it is also expected to make three big changes that investors are watching for in its statement and economic forecasts Wednesday afternoon.
  • The first is a change in interest-rate expectations: The Fed is widely expected to reduce its own projections for rate hikes.
  • Secondly, the Fed is seen removing language about "gradual" rate hikes from its statement.
  • The Fed is also expected to reduce its growth forecast.
Five experts on the Fed's big interest rate decision and what it means for markets
VIDEO4:0304:03
Five experts on the Fed's big interest rate decision and what it means for markets

The Federal Reserve is expected to unveil some big changes Wednesday afternoon when it releases its statement and new economic projections that could impact the course of markets into 2019.

This arguably could be the most important meeting so far for Fed Chairman Jerome Powell. The Federal Open Market Committee's statement and forecasts, released at 2 p.m. ET, come against a backdrop of market angst, where some market pros fear a recession and see the Fed's policy as part of the problem.

Powell has also been the target of an unprecedented level of criticism from President Donald Trump, who says the Fed's policy could hurt the economy's progress.

The Fed is widely expected to raise interest rates by a quarter point. That would take the Fed funds rate range to 2.25 to 2.50 percent. The Fed is also expected to revise lower its interest rate and economic forecast, and stress that it will base its decisions about further hikes on the economy's progress.

"It's the last big day of the year. But I do think the market is vulnerable to a 'we sold the rumor, maybe we buy the fact' set up. ... Stocks could go up, the dollar goes up, and bonds go down," said Marc Chandler, chief market strategist at Bannockburn Global Forex.

Ahead of the announcement, stocks were higher, the dollar was lower and 2-year and 10-year Treasury yields, which move opposite price, were lower.

Here's what the market pros are watching for:

1. Fewer interest rate hikes forecast

The Fed is expected to change its interest-rate guidance and lower its forecast for rate hikes. Those forecasts are presented with Fed economic projections. It is a so-called dot plot, or a chart formed from the anonymous forecasts by Fed officials on where they think the fed funds rate will be at given points in time.

Collectively, the Fed currently sees three rate hikes for next year. Economists expect them to drop from the median of three to two, and that would be viewed as dovish. More dovish would be if it lowered the forecast to just one for next year, or even dropped the expected rate hike from 2020, signaling an early end to rate hikes.

The Fed just raised interest rates — Here are three big takeaways
VIDEO2:0502:05
The Fed just raised interest rates — Here are three big takeaways

"Knee jerk would be to sell the dollar and buy equities," said Win Thin, foreign exchange strategist at Brown Brothers Harriman.

Market expectations, reflected in fed futures, are very different from current Fed forecasts for three rate hikes in 2019.

"I have 0.4 hikes priced into 2019. It's really a question of [the Fed] moving from three to two. I would be extremely surprised to see a drop to one," said Jon Hill, rate strategist at BMO. Hill said in a very thin market, the futures market is currently pointing to the potential for an eventual rate cut in 2020.

"It will be dovish compared to September but prices have adjusted way past the guidance in September. It would be a dovish change, but it could be a hawkish impulse in the market," Hill said.

2. 'Gradual' goes away from statement

Economists expect the Fed to remove language from its statement describing "further gradual increases" in interest rates. That would imply the Fed would now be more dependent on how the incoming economic data look than proceeding on a preset hiking path.

In its last statement, the Fed said: "The Committee expects that further gradual increases in the target range for the federal funds rate will be consistent with sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee's symmetric 2 percent objective over the medium term."

Jefferies economists wrote their own replacement language for the Fed, and suggested it would insert that as the Fed approaches the "neutral rate," its pace of rate hikes would moderate and be consistent with economic activity, strong labor market conditions and inflation expectations around the Fed's target of 2 percent. Neutral is the level where interest rates do not stimulate or slow the economy and it has been a point of debate. Economists mostly agree it's somewhere between 2.5 and 3.5 percent.

3. Slower growth and lower inflation in forecast

To go along with lowered rate forecasts, the Fed is expected to revise downward its growth forecast because of worsening financial conditions and weaker global growth. It could also possibly lower its interest rate expectations, in part because of the steep drop in oil prices.

"The gap between what the Fed is indicating and what the market is looking at is wide. I think the Fed does take a step toward the market," said Chandler. "The Fed is saying the economy is growing above trend, and the market is saying recession."

Chandler said he expects to see stronger economic growth and that the views of the Fed and markets are not likely to come together after this one meeting.

The Fed had forecast 2.5 percent growth for next year, and that could fall slightly. The longer-run rate is 1.8 percent, and strategists are watching to see if that forecast changes.

Source: JPMorgan Chase

"The bond market is pricing for an extremely dovish meeting. If the committee is extremely dovish, that shows large concerns about the growth outlook which could be negative for stocks. If it's too hawkish, that would be negative for stocks," said Hill.

What else to watch:

There are are a whole bunch of buzzwords markets are also watching for clues on policy.

For one, the Fed's balance sheet is the 800-pound gorilla that the Fed has not yet addressed, but that Trump tweeted about Tuesday.

TWEET

Powell could discuss it, and some strategists say it would take on much bigger importance if the Fed adds something about it to its statement.

Market pros have been looking for information on when the Fed could stop or slow the whittling away at its balance sheet, which it has done by lowering reinvestments. Powell has said the Fed would study the impact of cutting back to purchases of securities to replace those that are maturing on its balance sheet.

Besides the fed funds target rate, the Fed will likely raise the rate on interest on excess reserves by 20 basis points. It's a technical move to keep the fed funds rate within its target range.

Strategists said they are also keeping an eye out for language tweaks that could include how the Fed sees risks to the forecast and whether they remain balanced.

The Fed could also discuss changing financial conditions, which have tightened and in part include the stock market's volatile behavior. Comments on financial stability could also be important, as would an update from Powell on how the Fed views conditions in the credit market and with leveraged loans.

In his press briefing, which begins at 2:30 p.m. ET, Powell could talk about the implications of trade wars and the potential impact on the economy.

Powell could also make more comments about how close the Fed is to neutral, following his famous October statement that neutral was far away and his seeming reversal of that comment in November, when he assured the Fed was close to the balance point of not needing a rate hike or rate cut.

"If the committee is signaling we're getting close to the peak of rates this cycle, that's a different state of the world than where we were for 2017 and 2018 with this methodical, gradual rate increases," said Hill, adding markets would have to further adjust.

Purple tie?

Powell is expected to stress the Federal Reserve's independence, if pressed in the briefing about
Trump's criticism of Fed interest rate policy.

Hill believes Powell may be sending a subtle message in his tie choice, though the Fed chairman hasn't been about it.

"I hope he wears a purple tie. It's kind of bipartisan. He wore it in both June and September, and those were his press conference days. Maybe that's his favorite," said Hill.

Chandler said purple may be indicative of something else, rather than a blend of Democratic blue and Republican red.

"It's like the ancient Romans would have a purple thread going around to indicate a senator. ... This is royalty. This is the Fed's independence. They're going to raise interest rates today," he said.