Guah thinks the market temptation will be to read the moves as titling toward dovish, which he sees as a mistake. Recent public statements, particularly by long-time dovish Governor Lael Brainard, are pointing to concerns about inflation and market valuations that will lead to continued rate hikes through at least mid-2019.
That, however, is where things get interesting.
If the majority of economists are correct and economic growth cools heading into 2020, the Fed could have to make an abrupt change in policy. Next week’s meetings will allow officials to give their views on the economy, and investors may adapt their long-term strategist accordingly.
“Investors are increasingly underestimating the scope for rate cuts further ahead,” Andrew Hunter, U.S. economist for Capital Economics, said in a note. The problem, he said, “is with the idea that the Fed will be able to raise interest rates to that level without causing a significant slowdown in economic growth.”
“The fiscal stimulus will provide only a temporary boost to the economy and, as the stimulus fades and monetary tightening starts to take a more serious toll on activity, we continue to expect an economic downturn to force the Fed to back away from further rate hikes and eventually to reverse course,” Hunter added.
Markets had been mispricing Fed intentions for a good part of this year, not believing when officials indicated that four rate hikes were likely. That set up a scenario in which it was the market, not the Fed, that was behind the curve.
Lately, traders in the fed funds futures market have come around, assigning an 87 percent chance to a fourth increase in December, according to the CME. Additional hikes are being priced in for March and June of 2019. After that, it becomes more of a guessing game.
Next week’s meeting is likely to provide an opportunity for markets to make yet another adjustment to the Fed’s thinking.
“You’ve still got this tug-of-war in the market. The key is whether the economy is equipped to keep expanding and keep moving higher,” Prudential’s Krosby said. “This is a very important meeting.”