Federal Reserve Decision Day: What to Expect

The Federal Reserve’s hawkish pivot has already occurred. Now the central bank just needs to follow through.

It was just over two weeks ago that Fed Chair Jerome Powell told Congress it was time to retire the word “transitory” with regard to inflation. Powell signaled that the Fed is likely to accelerate the pace at which it will reduce its asset and bond purchases, launched in 2020 to combat the negative economic impact of Covid-driven lockdowns.

Since Powell’s Congressional testimony, the case for moving faster to tighten monetary policy has grown only stronger, based on a series of economic reports. The latest jobs report showed roughly 600,000 people returned to the labor force in November, driving the unemployment rate down to 4.2%. Consumer prices are rising at a rate not seen since 1982. And wholesale prices rose 9.6% year-over-year last month, the largest jump on record since the Labor Department began calculations of the 12-month data in 2010.

Economists now expect the Fed to announce at the close of its two-day policy-setting meeting on Wednesday afternoon that it will double the pace at which it will reduce its purchases of Treasury bonds and mortgage-backed securities. That would put the central bank on track to wind down the emergency bond-buying program by next March. “The Fed has all but pre-announced a faster taper,” Bank of America economists wrote this week.

That in turn would clear the way for an interest-rate increase in June, if not earlier. Wall Street and other Fed watchers will be on high alert on Wednesday for any indication of what the central bank’s timing might be. Powell has made clear in the past that he would like to see some space between the end of the asset-purchasing program and a liftoff in rates, notes Diane Swonk, the chief economist at Grant Thornton, but he is “willing to raise rates sooner than June if need be,” she adds.

The Fed’s so-called dot plot, which reflects expectations for future rate increases among individual Fed policy makers, will offer clues on Wednesday to the path forward. There is likely to be a major shift from September, the last time the policy makers released dot-plot projections; back then, they were evenly divided about whether they would raise rates at all next year. 

It is harder to predict the latest dot plot than some of the Fed’s other likely moves. For example, Powell has already said that he wants to move on from “transitory,’ so expect that word to drop out of the post-meeting policy statement.

Given recent improvements in the labor market and the latest spike in inflation, the dot plot could reflect expectations for as many as three or four hikes next year, economists say. Markets may view that as a hawkish turn, especially because it would be a fairly rapid shift from a September plot that showed a 50-50 chance of no rate increases next year, said Claudia Sahm, a former Federal Reserve economist.

“The dots are a wild card,” said Sahm, who is now with the Jain Family Institute. “Their forecasts tell you something about how they think about how the economic conditions relate to the right monetary-policy decision.”

Beyond that, Fed policy makers will be updating their forecasts for economic growth, inflation, and unemployment to better reflect the recent data.

And, as officials are likely to mark up their inflation forecasts and mark down their unemployment expectations, “for the first time, they’ll be signaling that they are chasing inflation instead of pre-empting it,” Swonk says.