The Fed will likely raise its key interest rate. It is all priced in, so what really matters is the stance and tone. We explore the key elements to be better prepared.
What are the FOMC members thinking now?
Here are a few elements they have in mind:
In other words, inflation and inflation expectations are returning to normal and the labor market is steadily improving, while some fiscal stimulus is coming, as well as potentially higher oil prices. There are a ton of other metrics, of course, plus the Fed looks at potential issues in the EU, but the general picture is improving.
A 25 bp rate hike is priced in, but the question is what will the tone be about policy going forward? Some FOMC members want to increase the Fed Funds Rate slowly but gradually to avoid the need for a steep and potentially destabilizing pace down the road. Others (including Yellen) want to have an even slower rate hike pace, since inflation and the employment rate remain on the low side and the global picture is filled with risk, which means that for these dovish members, the stance of monetary policy could remain quite expansionary for quite some time.
After several false signals and expectations, the market remains cautious and has put the Fed in the "dovish" category - "we will believe it when we see it" is the market bias now. But the Fed faces a very different situation than 1 year ago, as all the elements I described above were NOT aligned back then. What the Fed wants to avoid is to put a damper on momentum in growth, jobs, and inflation, as the economy is still FAR from overheating and they don't want to create massive capital flow and forex issues globally with a "surprizingly" hawkish tone.
However, the case for a gradual tightening may have become a bit more solid in the past months, especially with Trump's plans for infrastructure expenditures and detaxation, along with increasing oil prices. I see a non neligible possibility that the tone may prove slightly more hawkish than the market is currently expecting, but without going too far - a "dovish hawkish" dance, if you will. We will see.