- The Federal Reserve is expected to raise interest rates by 75 basis points Wednesday but also signal it could begin to slow down the size of its rate hikes in December.
- Markets are also braced for the Fed to end rate hikes in March at a level of 5%, and market pros say a more hawkish Fed could trigger a violent reaction.
- Fed Chair Jerome Powell is expected to sound somewhat hawkish in his briefing Wednesday and emphasize that the Fed's goal is to crush inflation.
The Federal Reserve is expected to raise interest rates by three-quarters of a percentage point Wednesday and then signal that it could reduce the size of its rate hikes starting as soon as December.
Markets are primed for the fourth 75-basis point hike in a row, and investors are anticipating the Fed will slow down its pace before winding down the rate-hiking cycle in March. A basis point is equal to 0.01 of a percentage point.
"We think they hike just to get to the end point. We do think they hike by 75. We think they do open the door to a step down in rate hikes beginning in December," said Michael Gapen, chief U.S. economist at Bank of America.
Gapen said he expects Fed Chair Jerome Powell to indicate during his press briefing that the Fed discussed slowing the pace of rate hikes but did not commit to it. He expects the Fed would then raise interest rates by a half percentage point in December.
"The November meeting isn't really about November. It's about December," Gapen said. He expects the Fed to raise rates to a level of 4.75% to 5% by spring, and that would be its terminal rate — or end point. The 75 basis point hike Wednesday would take the fed funds rate range to 3.75% to 4%, from a range of zero to 0.25% in March.
"The market is very fixated on the fact there's going to be 75 in November, 50 [basis points] in December, 25 on Feb. 1 and then probably another 25 in March," said Julian Emanuel, head of equity, derivatives and quantitative strategy at Evercore ISI. "So in reality, the market already thinks this is happening, and from my point of view, there's no way the outcome of his press conference is going to be more dovish than that."
The stock market has already rallied on expectations of a slowdown in rate hikes by the Fed, after a final 75 basis point hike Wednesday afternoon. But strategists also say the market's reaction could be violent if the Fed disappoints. The challenge for Powell will be to walk a fine line between signaling less-aggressive hikes are possible and upholding the Fed's pledge to battle inflation.
For that reason, market pros expect the Fed chair to sound hawkish, and that could rattle stocks and send bond yields higher. Yields move opposite price.
"I think he's going to try to execute the fine art of getting off the 75 [basis points] without creating euphoria and influencing financial conditions too easy," said Rick Rieder, BlackRock chief investment officer of global fixed income. "I think the way the market is pricing, I think that's what they're going to do, but I think he's really got to thread the needle on not getting people too excited about the direction of travel. Fighting inflation is their primary objective."
As the Fed has raised interest rates, the economy is beginning to show signs of slowing. The housing market is slumping, as some mortgage rates have nearly doubled. The 30-year fixed rate mortgage was at 7.08% in the week of Oct. 28, up from 3.85% in March, according to Freddie Mac.
"I think [Powell] will say that four 75-basis point hikes is an awful lot and with this long and variable lag, you need to step back and see the impact. You're seeing it in housing. You're starting to see it in autos," said Rieder. "You're seeing it in some of the retailer slowdowns, and you're certainly seeing it in the surveys. I think the idea that you're slowing, it's important how he describes it."
The Fed should be dependent on incoming data, and while inflation is coming down, the pace of decline is unclear, Rieder said.
"If inflation continues to be surpisingly high, he shouldn't shut off his options," he said.
Consumer inflation in September ran at a hot 8.2% annual basis.
Gapen expects the economy to dip into a shallow recession in the first quarter. He said the equity market would be concerned if inflation were to stay so high the Fed would have to raise rates even more sharply than expected, threatening the economy even more.
"The markets want to be relieved, particualy the equity maket," said Rieder. "I think what happens to the equity market and the bond market are different because of the technicals and the leverage. ... But I think the market wants to believe that the Fed, they're going to get to 5% and stay there for awhile. People are tired of getting bludgeoned, and I think they want to believe the bludgeoning is over."