The Fed has a fine line to walk today but in all likelihood, it will just reaffirm the status quo in the market in the past few weeks
There are a couple of things we can expect from the Fed today but essentially, Powell & co. will want to try and maintain a more dovish stance - for as long as they can get away with that - but they could end up communicating otherwise.
Let's take a look at some of the key details going into the FOMC meeting later.
The infamous dot plotsThis is arguably going to be the first key thing that the market will focus on later today, alongside the Fed's latest economic projections.
In the previous projection (↑), there were five dots that showed at least one rate hike by 2023 and that figure is surely going to increase later today.
The big question though is by how much? And what will the median projection be after?
If the median reflects a rate hike by the end of 2023, it only helps to reaffirm market pricing and is a major dent in the Fed's commitment to "keep rates lower for longer".
In essence, if there is a median reflecting a rate hike, it may not matter much what Powell has to say unless he clearly addresses this particular shift in projection.
Verdict: Almost certainly more hawkish bias i.e. ⬆️ yields, ⬆️ dollar. But the degree of hawkishness will depend on what the dots signify (if there is a median hike in 2023).
The SLR decision
There are concerns on this that if the Fed does not extend the SLR exemption beyond 31 March, that it will cause constraints in the Treasury and repo market.
So, expect the market to base some of its initial reaction on this alongside the dot plots above. That said, if the Fed sees fit to not extend the SLR exemption, then they surely (or at least rightfully should) know it isn't really going to impede market functionality.
As such, the initial knee-jerk reaction may be a bit exacerbated by this decision but expect market participants to feel more comfortable about this rather quickly.
However, if the Fed does want to try and offer some pushback, an extension wouldn't really harm anyone except for its own control over the bond market.
Verdict: Likely no extension i.e. ⬆️ yields, ⬆️ dollar. But market reaction may be short-lived in such an instance, with other factors taking precedence.
What will Powell do?
Honestly, I don't expect Powell to venture too far off from the script at the start of the month here - where he didn't offer any pushback to the bond market.
If anything, just expect Powell to continue to reiterate the Fed's more dovish stance and how they are still some ways from reaching their labour market objectives.
Much like other central banks, he is likely to just question if the upcoming expected rise in inflation will just be transitory/temporary or will it be a persistent development.
As such, he is just going to offer more caution and negate - but not push back too firmly - the action in Treasuries. And as we have come to know, the market is more than likely to easily brush aside all of Powell's remarks and stick with the current theme.
Adding to this is that if the dot plots show a median rate hike for 2023, it also counteracts Powell's likely attempt to downplay the Fed's stance of "not going to withdraw stimulus any time soon".
The bar is high for Powell to push back. It is not saying that he can't but if he wanted to, he would've done so already two weeks ago.
Verdict: Almost certainly more dovish i.e. ⬇️ yields, ⬇️ dollar. But expect the other focus points to take more importance as Powell isn't likely to offer anything new, though the risk is that he may sound extra dovish and push back against the bond market/rates.
Conclusion
If the dot plots show a median rate hike for 2023, I reckon that is likely to overshadow everything else as it reflects 'what the market wants to see'.
Powell holds the cards as to push back against such sentiment but given how he didn't feel the need to two weeks ago, it is doubtful he'll have a change of heart today.
As such, it is a tall order for the Fed to counteract the latest bond market developments and even if Treasuries do find some footing today, it isn't likely to last.
Given the more optimistic economic outlook and the reflation emphasis, the path of least resistance is for Treasuries to keep lower i.e. higher yields.
One thing to watch today is how will the short-end of the curve react if the dot plots reflect one rate hike for 2023. That may very well spook equities as well later in the day.
In any case, the Fed may look to guide the market accordingly if rate hike expectations go too far. But for now, with 70% odds priced in for December 2022, there's some limitation for the market to extend the latest moves, all things considered.
