Despite the big spike in inflation, the Federal Reserve is set to signal on Wedesday that it is not going to change interest rate policy anytime soon -- at least through the end of 2022, economists say.
"The message this week will likely be a heavy dose of 'still a long way to go' sprinkled with concerns about upside risks to inflation," wrote Michael Gapen, chief U.S. economist at Barclays.
The Fed meets Tuesday and Wednesday this week against a backdrop of the consumer price index up 5% annual rate.
The Fed is still buying $80 billion of Treasurys and $40 billion of mortgage-backed securities each month along with keeping its benchmark rate close to zero, in order to support the economy.
Fed officials have guided the market that it won't scale back the asset purchases until it sees "substantial further progress" towards its unemployment target in particular as the economy recovers from the pandemic. Slowing back asset purchases would be taking the central bank's foot off the gas -- a long way from actually tapping on the brakes with higher interest rates.
Economists think markets have been so far surprisingly complacent about inflation. The yield on the 10-year Treasury note has fallen to 1.5% from closer to 1.64% just after the Fed's last meeting in late April.
Here's a look at what economists and investors will be watching for Wednesday when the Fed concludes the two-day meeting. Fed officials will release a statement at 2pm Eastern followed by a press conference from Fed Chairman Jerome Powell at 2:30 p.m.
Inflation is transitory
The Fed statement is widely expected to repeat the phrase that the pickup in inflation "largely reflects transitory factors." The Fed may drive this point home in its updated economic forecasts. In March, the Fed had core PCE inflation at 2.2% in 2021, 2% in 2022 and 2.1% in 2023. The 2021 forecast of core inflation is likely to rise but the Fed is expected to keep 2023 core inflation unchanged.
'Talking about talking about' tapering
Fed officials are expected to discuss slowing down, or tapering, asset purchases, but only in a preliminary way without laying out any plans. "We expect Chair Powell to stress that all, or almost all, participants, see tapering action as very premature," wrote Steve Englander, head of North American macro strategy at Standard Chartered Bank.
Tolerate a rising expectation of higher rates over 2023-2024
If inflation is more persistent than the Fed now believes, the central bank needs to signal it will do what it needs to do to keep inflation under control. "In that record, the Fed will, if not encourage, at least tolerate, a rising expectation of [higher] rates over 2023 and 2024," said Bruce Kazman, chief economist at JPMorgan Chase, in an interview on Bloomberg Television.
Consequently, the median dot on the chart that signal's the Fed's consensus could signal the first rate hike in 2023. In March, 11 of 18 top Fed officials thought policy would be unchanged. Only four of 18 officials were projecting a rate hike in 2022.
Many other economists think it is still unlikely the median projection will change from the current rate close to zero.
Will Powell repeat that the Fed is 'a long way' from its goals and 'some time' for substantial further progress?
Jim O'Sullivan, thinks the Fed has to start getting away from this language, which Powell used to signal that policy would remain unchanged. "The longer you leave it in place, the bigger deal it is when you drop it," he said. So he thinks Powell will no longer say that it will be "some time" before the economy reaches the benchmark of "some further progress" to allow the Fed to taper asset purchases. This won't be a signal of imminent tapering. "It is not in the next three months -- it could happen by the end of the year. O'Sullivan thinks the Fed will show patience and not start tapering until next March.
Rubeela Farooqi, chief U.S. economist at High Frequency Economics, wrote she wouldn't be shocked if Powell set out conditions for "substantial further progress." This would go a long way toward removing uncertainty about when the Fed might reach the threshold, she said.