FOMC Preview: Will There Be a Hawkish Pause or an End to Rate Hikes?

At 2 p.m. EDT on September 20, the Federal Reserve will make the decision on interest rates and release the latest quarterly economic forecast and interest rate dot plot. Economists see the Fed holding rates steady when their meeting ends Wednesday.

Fed Chairman Powell will hold a press conference later. His speech at the central bank's annual summit in Jackson Hole, Wyo., last month seemed to satisfy both hawks and doves, with a combination of anti-inflation rhetoric and dovish details that revealed no concrete plans to raise interest rates or not in the coming meetings. The tone of the remarks is likely to continue to be reflected in this week's meeting.

The median forecast of economists surveyed by Bloomberg shows that the Fed may raise the economic growth rate to 2.0% in 2023 (the Fed predicted this year's growth rate to be 1.0% in June), and the unemployment rate will be lowered from 4.1% to 3.9%. The PCE price index remains unchanged while core PCE inflation might be slightly revised down.

The resilience of the US economy can be seen in recent increases in the Redbook retail sales data. The index increased by 4.60 percent in the week ending September 9th over the same week in the previous year.

The latest Michigan University's statistics show consumers expect the 1-year horizon inflation rate to decrease to 3.1% from 3.5% and the 5-year inflation rate to drop to 2.7% from 3.0%. It could reinforce the belief that inflation may continue to alleviate until the end of this year, although the recent rise in oil prices could also cast uncertainty on the outlook.

The survey by Bloomberg shows that 45% of economists predict that the US economy will be in recession within the next 12 months, of which 55% believe that the recession will occur in the first quarter of next year.

Considering that forecasters have been blindsided by past recessions, the Federal Reserve increasingly have supplemented traditional forecasts with “fan charts” that put probability bands around a “mean forecast.” The “mean forecast” of the model by Bloomberg sees the unemployment rate rising to 3.9% by the end of 2023 — matching the prevailing consensus for a soft landing. However, the most notable finding from the model results is that the risk to the unemployment outlook is asymmetrically skewed to the upside.

Although the Fed may pause raising interest rates in September, the Fed's balance sheet still steadily declined on the central bank's gradual reductions of Treasuries and MBS. This means that U.S. monetary policy can still remain restrictive with the quantitative tools.

What we can refer to is the eurozone interest rate hike may have ended. The biggest change in ECB's latest meeting statement is "Based on the current assessment, we believe that the key interest rate has reached a level that can be maintained for a sufficient period of time." The market interpreted it as implying that the interest rate has reached its peak.

Although European Central Bank President Christine Lagarde denied the statement that "the interest rate peak has been reached" at the press conference, it is clear that market pricing is more biased towards the end of interest rate hikes. Overnight swaps show that the market expects that the probability of the European Central Bank raising interest rates in October is only about 20%.

The European Central Bank's policy path guides the Federal Reserve, because the increase in interest rate differentials between Europe and the United States may lead to further weakness in the euro, thereby affecting U.S. exports and economic resilience.