The Federal Reserve is on track to slow the pace of monetary-policy tightening on Wednesday by raising interest rates by a modest quarter of a percentage point, its smallest increase in nearly a year. But don't mistake the central bank's downshift for a dovish pivot.
With a 25-basis-point interest-rate hike all but locked in (a basis point is a hundredth of a percentage point), the biggest news on Wednesday will come not from the Fed's policy moves but the statement and press conference that will follow its two-day policy meeting. Fed Chairman Jerome Powell has been emphasizing for months that the future pace of tightening is less important than how high interest rates ultimately rise, and investors and economists will be parsing his words for clues as to where the federal-funds rate might ultimately land.
For Powell, the challenge will be to acknowledge that the Fed is slowing its pace while emphasizing, as he has in several past public appearances, that the central bank still has plenty of work to do. His press conference will likely come off as more hawkish than the interest-rate hike itself, which markets will likely interpret as a softer approach, Fed analysts say. Ahead of the meeting, investors are pricing in a nearly 99% chance of a 25 basis-point increase, according to CME data.
"Policymakers appear to have increased confidence that inflation is on a path lower, but the Fed is not yet convinced that inflationary pressures will dissipate quickly," a team of Bank of America economists led by Michael Gapen wrote.
"The decision may be for a smaller 25bp hike," they wrote., "but the Fed will want to avoid the interpretation that this implies a lower terminal rate or an earlier onset of rate cuts than the committee viewed as appropriate when it last met in December."
Wednesday's policy statement and press conference come as the central bank is at something of a crossroads. The U.S. economy is broadly slowing and inflation, which has fallen steadily since the summer, appears to be well past its peak.
But despite months of cooling, inflation remains significantly above where the Fed would like to see it. Core PCE, the Fed's preferred measure of inflation, fell to 4.4% in December but remains at more than double the central bank's 2% target. Central-bank officials worry that even as goods prices deflate and housing costs slow, inflation will hit a floor well above its 2% target due to persistent strength in services sectors.
The difficulty now for the Fed is to figure out how much further to raise rates to slow price growth back to target without going so far as to push the economy into a recession. It means the central bank's job has become much more difficult than it was for much of the past year, when the only move was to tighten monetary policy and to do it quickly.
Further complicating the picture, the Fed at times is working against financial markets, which have begun to see softening economic data as a signal that the tightening is nearly done and that it will cut rates this year. And, if souring economic data spark a market rally due to anticipation that the end of rate hikes is near, it could loosen monetary conditions and, in turn, force further tightening.
All that explains why Powell is likely to focus Wednesday on driving home the point that the Fed will keep tightening until it is confident inflation is on its way down to 2%, likely regardless of the economic fallout.
"Now is not the time for nuance," says Ronald Temple, chief market strategist at Lazard. "With a 25 [basis point] hike already discounted by markets, Powell's task is to unambiguously signal the Fed's commitment to tame inflation."