The Fed’s High Hurdle

Today, the Federal Reserve (Fed) kicks off its second two-day meeting of 2019, and financial markets have high expectations for the outcome.

The Fed will likely hold steady on the pause in rate hikes this week, and market participants are overwhelmingly expecting the Fed to keep rates unchanged and reiterate a commit to flexibility down the road. As shown in the LPL Chart of the Day, futures traders are pricing in a 71% probability of a stagnant fed funds rate through the end of 2019 and a 29% chance of a rate cut.

Market Expectations Take U-Turn With Federal Reserve

Beyond the rate announcement, Fed Chair Jerome Powell could give more color on future policy, as the Fed is slated to update its “dot plot” (or policymakers’ rate projections) at this meeting. Powell could also provide more commentary on the Fed’s balance-sheet reduction plans, which could change with the Fed’s new flexible stance.

“Powell may be tasked with a difficult balancing act in his press conference as he weighs in on slowing, but sound U.S. data and tenuous global affairs,” said LPL Research Chief Investment Strategist John Lynch. “While we don’t think policymakers should bow to markets in deciding on policy, the Fed’s acknowledgement of global clarity is especially important these days.”

Markets are extra sensitive to Fed commentary these days as pockets of the U.S. economy weaken along with signs of a global slowdown. The S&P 500 Index has closed up or down at least 1.5% on each of the past two Fed announcement days, the first time that’s happened since October 2011. U.S. stocks are also nearing record highs once again as investors price in a cautious scenario for policy, considering the macroeconomic environment hasn’t changed much since the Fed paused rate hikes in January.

We don’t anticipate the Fed’s patient tone will change much in this meeting, and we expect the Fed’s dot plot to either project unchanged or slightly higher interest rates through the end of 2019. Fundamentally, we see the bulk of global tensions as the product of near-term headwinds. As these headwinds subside, U.S. growth could stabilize and inflation could pick up modestly. If this happens, the Fed may hike once in the second half of the year after carefully communicating a change in stance to markets.

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