What Does the Market Expect From The Fed

US Federal Reserve will decide at at 7 PM GMT. Will Powell communicate more dovish policy?

Market expectations clearly indicate no changes to interest rates during today’s meeting. However, macroeconomic forecasts, particularly those related to economic growth, could prove crucial. The market will also closely monitor the expectations of Fed officials regarding further rate cuts, commonly referred to as the “dot plot.”

Additionally, investors are speculating whether the Fed will announce changes to its balance sheet reduction program to avoid liquidity issues similar to those observed in 2019. The decision will be published at 6 PM CET GMT, while Powell’s press conference will begin 30 minutes later.

What Does the Market Expect?

Interest Rates: The FOMC is likely to unanimously keep interest rates within the 4.25%-4.50% range.

Post-Meeting Statement: A slight adjustment to the Fed’s labor market assessment may occur, indicating that the unemployment rate has risen but remains at a low level.

Inflation Forecasts

The median of participants is expected to raise core PCE inflation projections across the entire forecast horizon:

• For 2025: Revised up to 2.8% (from 2.5% in the December forecast)
• For 2026: Revised up to 2.4% (from 2.2%)
• For 2027: Revised up to 2.2% (from 2.0%)
  Considering the potential impact of higher tariffs, these projections could be revised even higher.

GDP Growth Forecasts

Real GDP growth forecasts are expected to be revised downward:

• For 2025: Expected to be cut to 1.7% (from 2.1%)
• For 2026 and 2027: Likely revised to 1.7% (from 2.0% and 1.9%, respectively)
  Growth could be constrained by trade uncertainties, and a short-lived recession remains a possibility, given the substantial trade deficit recorded last month—an issue that may persist as companies attempt to bypass tariffs.

Unemployment Forecasts

Given lower GDP growth projections, the unemployment rate is expected to rise:

• For 2025: Likely revised to 4.4% (from 4.3%)
• For 2026 and 2027: Also expected at 4.4% (from 4.3%)
  Currently, the unemployment rate stands at 4.1%.

Dot Plot

Interest rate projections are expected to lean hawkish. There is nearly a 50% chance that the median projection will indicate one or two rate cuts this year (compared to two in December’s forecast). However, forecasts could show greater dispersion among participants, as inflationary risks persist on one side, while weaker economic growth looms on the other.

Powell’s Stance

Powell is likely to state that the U.S. economy remains in solid shape and that it is too early to assess the impact of U.S. trade policy on economic growth. He is also expected to reiterate that the Fed is in no rush to cut rates, but if labor market conditions deteriorate significantly, the central bank will be ready to intervene.

Expectations for rate cuts have been revised down once more, with the market now pricing in only two cuts this year, with the first one not expected until July. Source: Bloomberg Finance LP

Fed Put?

Bloomberg Intelligence suggests that the Fed may adjust its strategy, considering the recent sharp sell-off on Wall Street and the lack of market support from the new U.S. administration. However, the Fed has consistently shown reluctance to cut rates amid heightened economic uncertainty.

If the Fed maintains a clear stance against rate cuts at this moment and reduces the number of projected rate moves, market conditions could deteriorate further.

Looking at the two previous recessions (excluding the brief 2020 downturn), interest rate cuts have historically coincided with the early stages of economic troubles. The yield curve has inverted and is hovering near levels that have historically signaled the onset of a recession. In both previous cases, Wall Street experienced sharp declines. However, it’s worth noting that in each recession, the recovery period for U.S. stocks has become progressively shorter. Will this trend continue? Source: Bloomberg Finance LP, XTB

What About the Fed’s Balance Sheet?

The Fed has already reduced its balance sheet by over $2 trillion from its peak, bringing it back to June 2020 levels. Although it remains elevated, considering the first wave of pandemic-era asset purchases, the pace of reduction has been significantly faster than during the previous quantitative tightening (QT) cycle.

The new U.S. administration will likely need to raise the debt ceiling again and issue more debt. The Fed may seek to avoid excessively reducing reserves in the banking system and could pause further balance sheet reductions. However, during recent meetings, the Fed has not signaled any intention to do so.

While the Fed’s balance sheet remains high, the magnitude of its reduction over the past three years has been remarkable. Source: Bloomberg Finance LP

What to expect from March Fed Meeting

The main takeaway from the March meeting is likely to be that the FOMC will only consider rate cuts once the labor market shows clear signs of deterioration. This could come too late to prevent an economic slowdown, forcing the Fed to catch up with more aggressive rate cuts later in the year.

In summary, updated projections could reflect a slightly stagflationary tone, and the dot plot may surprise with a more hawkish stance. The projections are expected to indicate that the FOMC will not react to early signs of labor market weakness but will wait for clear deterioration before resuming rate cuts. This raises the risk of an economic slowdown, which could have significant consequences for U.S. equities, while at the same time, at least in the short term, supporting the U.S. dollar.

On the other hand, capital is already flowing out of the U.S. to other regions of the world, despite the current stance of major central banks.

How Will Markets React?

The U.S. dollar is strengthening against the euro ahead of today’s decision. The recent EUR/USD rally has not aligned with movements in U.S. Treasury yields, although it’s essential to consider rising European yields, which have provided support for the euro.

A hawkish Fed stance could be positive for the dollar, but at the same time, significantly lower growth forecasts could suggest that the Fed may be forced into larger and more rapid rate cuts later in the year to avoid a recession. The risk remains that the Fed may act too late in initiating cuts.

Source: xStation5

The S&P 500 (US500) is attempting to recover from the sharp declines of recent weeks, but it has failed to break above a critical resistance zone near 5,700 and the 250-day moving average. A hawkish Fed could further dampen investor sentiment, but if the Fed signals any pause in balance sheet reductions, it could provide a strong positive signal for equities.

Source: xStation5

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