By Daleep Singh, Chief Global Economist, Head of Global Macroeconomic Research, at PGIM Fixed Income
What is “somewhat higher” on the peak rate? The single most important datapoint in the Fed’s quarterly projections will be its median expectation for the peak policy rate in this cycle. Chair Powell signaled at his Brookings appearance in late November that the rate would likely be “somewhat higher” than thought in its September projections. The market has now priced this to mean a peak policy rate of 5%, up by 25 basis points from the Fed’s previous forecast. In light of the hot wage number in the November jobs report, however – and the outsized importance of the inflation print that will drop just one day before the Fed’s meeting concludes – this may be a game-time decision for Chair Powell and colleagues.
To what extent does the Fed carve out further flexibility on the pace, peak, and length of the tightening campaign? It could do so by amending the statement to anticipate “some further increase” in the target policy rate will be appropriate, rather than “ongoing increases”. Chair Powell could also reinforce in the presser that given the time lags required for tighter monetary policy to reduce inflation – and the context in which so many central banks are slamming the brakes so hard at once in an already soft global economy – slowing down and eventually pausing are prudent forms of risk management.
How eager is Chair Powell to undercut a Santa rally? The risk of carving out substantially more flexibility on the pace, peak, and length of the Fed’s tightening cycle is that such a message will receive a dovish interpretation by market participants, trigger a further loosening of financial conditions, and complicate the Fed’s path to meeting its inflation objective. To lean against this risk, we expect Chair Powell will be at pains to emphasize the tightening campaign “still has some ways to go” to bring the labor market into balance and cool off services prices in the economy.