Fed Chairman Powell will try to soothe markets, but that may not work

Federal Reserve Chairman Jerome Powell will try to avoid sounding hawkish in any way when he talks Wednesday afternoon about the Fed’s commitment to its easing policies, particularly its bond-buying program.

The Fed is not expected to take any actions at its January meeting, and it will likely reaffirm its commitment to low interest rates and other easing policies when it issues its statement at 2 p.m. ET.

When Powell speaks at 2:30 p.m. ET, he is also expected to acknowledge that the economy has softened, consumer spending has weakened and the labor market has deteriorated since the December meeting.

“He’s going to say rates are staying low,” said John Briggs, head of global strategy at NatWest Markets. “We need more fiscal [stimulus]. We’re not out of the woods with the virus, and rates will stay low for a substantial period. There’s still lots of progress to be made.”

The market is keyed on what Powell will say about the Fed’s bond purchases, the subject of much speculation and something the Federal Open Market Committee was likely to discuss behind closed doors.

Stocks were getting hit on Wednesday with the Dow down 1%.

The Fed purchases $80 billion in Treasurys and $40 billion mortgage securities each month. It is expected to taper those purchases when it views the economy is strong enough.

CNBC’s Fed survey found 60% of the 32 Fed watchers surveyed expect policymakers to begin paring back those purchases in the next 12 months, with most of them starting in November. But bond strategists say the market could be negatively surprised by that, at this point.

“I think I’d focus more on the taper talk. If Powell puts that down emphatically that’s one thing.
If he’s wishy washy, that’s another,” said Michael Schumacher, director rates at Wells Fargo. Rates, which move opposite bond prices, rose recently as some Fed officials, including Atlanta Fed President Raphael Bostic, mentioned the potential for the Fed to reduce its purchases.

But Powell and Vice Chairman Richard Clarida moved to squash the speculation. Clarida said he expects to see the same pace of purchases through the end of the year, and Powell said the Fed will begin communicating about the program well before it begins tapering. Yields were also lifted by the prospect of more government spending but have come down this week on the view the next fiscal stimulus package may be smaller than proposed.

Rick Rieder, BlackRock CIO global fixed income, said he sees the economy picking up more than widely expected, even with the softer payroll data. He said glimpses of improvement are showing up in things like the Philly Fed survey and strength in manufacturing, housing and construction.

“I think in the second and third quarter, growth is going to be significantly higher, and people will start to interpret that as the Fed is not going to to stay on hold forever,” he said. “I think in June, the Fed will start its discussion on tapering, and I’m not sure they actually begin the taper this year. … I think there’s a possibility.”

Rieder said the Fed will have to go slowly to introduce tapering to the market. It will also have to see how it is received and have the flexibility to reverse course if there’s a strong market reaction that sends interest rates suddenly higher.

As for Wednesday, he expects Powell to support President Joe Biden’s $1.9 trillion stimulus program.

“They certainly won’t give numbers, but I think they’ll point to a number of things. One is that the system can handle more fiscal policy and the Fed is willing and able to support it [through bond buying and interest rates],” he said. “The Fed is now the co-pilot to the fiscal, and I think they’ll do what they can to keep the policy well-supported by monetary policy.”

The Fed is also expected to reiterate that the course of the economy will be determined by the coronavirus.

Bank of America strategists say little is expected from this week’s Fed meeting but they see a risk of the Fed moving the markets. They do not expect the Fed to taper its bond purchases until the second half of next year, but it could move sooner if there is a fiscal stimulus package early this year to help the economy.

“Markets are expecting little at this meeting, but likely see Fed communication risks as asymmetric: it will be hard for the Fed to sound more dovish but easy for the Fed to sound more hawkish. As such, markets may misinterpret Chair Powell’s discussions around upside risk to be hawkish,” the strategists said in a note.