What the Fed Will Do—and Why

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The big economic story today will be the end of the regular meeting of the Fed and what it decides to do about interest rates. Markets are expecting a 25 bp increase, to a range of 5 percent to 5.25 percent, with a slight bet on no hike at all. This is the baseline that the commentariat will be reacting to once the news comes out this afternoon.

I agree that a 25 bp hike is the likely outcome, to the point that anything else would be a bit of a shock and generate a market reaction. In fact, that reaction is one of the reasons that hike is so likely. But because of that, for this meeting especially, it is important to look beyond the numbers (as we do) and think about what that 25 bp hike means in the broader context.

Consider the Variables

As usual, the two variables the Fed is looking at are employment and inflation. For employment, we have seen a slowdown, but the numbers are still quite strong despite that. This means the Fed’s job isn’t done there. For inflation, with wage growth and spending still growing, the recent declines are good news. Again, the data is saying the Fed isn’t done yet. Both of these variables suggest more rate hikes are ahead. Other metrics say the same.

But markets are counting on a much more dovish approach. There is, as I noted, a small chance priced in that we don’t get a rate hike at all today. Markets are pricing rate cuts soon. And most of the commentary I see is saying the same thing. Which is why the important news today won’t come from the Fed’s statement (regardless of the 25 bp hike) but from the press conference. Once again, Chair Powell is going to hold center stage.

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