Investing.com –With the Federal Reserve (Fed) widely expected to raise the fed funds target range by a quarter point to a range between 1.0%-1.25% at the conclusion of its two-day policy meeting at 2:00PM ET (18:00GMT) on Wednesday, markets hope to receive signals on whether the central bank’s following move will involve another increase in the price of money or the beginning of the long-awaited balance sheet normalization.
“Ironically, the third hike since the U.S. election last November is so greatly assumed that it is not the most important element of the FOMC (Federal Open Market Committee that makes policy decisions) meeting,” experts at Brown Brothers Harriman (BBH) said.
Recent surveys of economists by both Reuters and Bloomberg signaled that policy tightening was a done deal, while Fed fund futures put the odds for the hike at no less than 91.8%, according to Investing.com's Fed Rate Monitor Tool.
Eyes on adjustments to Fed forecasts
The U.S. central bank will also release its latest forecasts for economic growth and interest rates, known as the "dot-plot", at the same time of the announcement.
In the past, Fed members have largely agreed that weak first quarter growth was expected to be transitory, but other data has put the central bank between a rock and hard place with respect to their dual mandate.
The most recent employment report showed that the jobless rate hit a 16-year low and most experts consider the U.S. economy to be at full employment.
However, the Fed’s other responsibility, price stability, has been reticent to return to normal levels with policymakers’ favorite inflation measure, core PCE, declining for three consecutive months.
Bank of America Merrill Lynch (BofAML) analysts suggested that the forecasts will reflect the lower jobless rate and also see a downward revision to core PCE inflation for this year, although maintaining the estimate for 2018 at 2%.
“We think the statement will continue to reiterate that the weakness in inflation is transitory, but may note that the inflation data are worth monitoring in coming months,” they said.
These experts also predict that the “dots are unlikely to budge”, referring to the dot plot that maps out, anonymously, Fed members’ projections for interest rates.
“While the removal of former (Fed) governor Tarullo’s forecast will naturally push the median expectation higher, we think this will be offset by other officials lowering the trajectory slightly,” BofAML concluded.
Yellen watched for signals of future Fed action
With this in mind, the focus, once again, is likely to be on Fed chair Janet Yellen’s press conference at 2:30PM ET (20:30GMT), as investors look for any hawkish change in tone about the economy or future rate hikes.
Market players will also pay close attention to details of the Fed's plan to reduce its $4.5 trillion balance sheet later this year.
“The press conference should provide some clarity on whether the next tightening step after June will be balance sheet normalization or a third funds rate hike,” Goldman Sachs economists stated.
Bloomberg and Reuters surveys of experts seemed to coincide with bets for another 25 basis point hike in September or the third quarter, respectively.
However, Fed fund futures currently price the chance for a September increase at only around 24%.
Despite the fact that the median Fed policymaker forecast back in March was for two more rate increases by year-end, markets put the chance for another hike by December below the 50% threshold at around 41%.
In general, the idea behind some analysts’ bets on a September hike seems correlated to the projection that the Fed will take a pause on rates in December in order to proceed with balance sheet reduction.
Goldman admitted that it is hoping for more clarity later on Wednesday, but were still leaning more towards the next policy meeting with a press conference for the balance sheet normalization.
“We expect a detailed announcement in September, but would not be surprised if it came in December as guidance has been mixed,” these experts said.
“We think that announcing the start of balance sheet adjustment in September and keeping open the option of foregoing the third 2017 hike is the more prudent course of action given the mixed recent data and the potential for fiscal turmoil in Washington in Q3 related to the need for a debt ceiling hike and an extension of spending authority,” they explained, placing their bets on the “actual start of runoff of assets in October”.
Morgan Stanley expressed a very similar view, projecting that the Fed would make the September announcement with balance sheet reduction beginning in October with a scheduled decrease of $5 billion each in mortgage backed securities and Treasuries to be paid down from October to December, $10 billion from January to March, $15 billion from April to June and $20 billion from July forward.
“Then we anticipate rate hikes resuming at each press conference meeting through 2018, which would (leave) the fed funds target at 2.25%-2.50% at the end of next year,” these experts said.
While markets awaited the announcement and Yellen’s posterior appearance on Wednesday, U.S. futures pointed to a flat open. The blue-chip Dow futures advanced 15 points, or 0.07%, at 4:01AM ET (8:01GMT), the S&P 500 futures inched up less than a point, or 0.01%, while the tech-heavy Nasdaq 100 futures edged forward 2 points, or 0.03%.
The dollar showed little movement against major rivals. The U.S. dollar index, which measures the greenback’s strength against a trade-weighted basket of six major currencies, was unchanged at 96.97 by 4:03AM ET (8:03GMT).
Gold for August delivery on the Comex division of the New York Mercantile Exchange inched forward. At 4:04AM ET (8:04GMT), the precious metal was last up just 51 cents, or around 0.03%, at $1,269.11.
Finally, the yield on the 10-year Treasury slipped 0.3 basis points to 2.204% at 4:05AM ET (8:05GMT).
Stay up-to-date on market expectations for changes in U.S. interest rates with Investing.com's Fed Rate Monitor Tool: