Dovish Fed no more? Wednesday's policy meeting could yield a date for rate hike

The Federal Reserve’s policy meeting this week could see the central bank drop the term ‘patient’ from its dovish rhetoric and move toward hinting on the timing of the first rate hike.

At least, that’s what the market is looking for. The Fed has spent the past 12-months holding off from offering certainty over the timing over the first rise in interest rates, leaving financial markets to obsessively punt on a conceivable date for such a move.

As analysts at Exane BNP Paribas put it, “US markets are banging the drum for Fed tightening.” They note that a few weeks ago there were still many who doubted rate hikes would come at all this year, but two strong payroll reports (January and February) have significantly shifted the debate in the opposite direction.

“While the Fed has yet to hike rates, anticipation in markets has already pushed bond yields up, especially at the short end,” added the analysts at Exane.

It’s not only the rise in US Treasury bond yields that’s screaming out for a rate hike. The behaviour of the US dollar and US stock indices both advancing to fresh records since the start of this year, combine to add further pressure on the Fed to acknowledge that a rate hike is on the near-term horizon.

Wednesday’s outcome is likely to show the Fed staying pat on policies for now however, it won’t stop market participants betting on a rate hike as early as June due to the improving economic fundamentals. “With the unemployment rate already within the Fed’s longer-run range of full employment of 5.2% to 5.5% and with the funds rate still at an emergency level nearly six years after the recession ended, financial markets should begin to prepare for higher interest rates,” said Joseph LaVorgna, economist at Deutsche Bank, who pencils in a rate hike at the June 17 meeting.

That said, LaVorgna noted that inflation has moved significantly further away from the Fed’s 2% target over the past few months, but importantly, the relative change in inflation has been larger than the relative change in the unemployment rate, which has fallen at a pretty consistent pace. “This means that while some Fed members may want the flexibility to move as soon as June, lower than expected inflation affords them more leeway to hike later,” said LaVorgna.

At the same time, with oil prices continuing to head south and the US dollar relentlessly moving north, the Fed could be pushed to delay the rate hike until later this year. Lower oil and stronger dollar present major risks for the US economy in the long-term and importantly, if, the Fed give both assets air-time by expressing concerns about the implications on the US economy, then it’s likely the market will read Wednesday’s meeting as dovish rather than hawkish.

For financial markets, the biggest tell-tale sign for impending rate hikes will be to gauge if the gap between dovish and hawkish rhetoric is tightening. Since Yellen's appointment as Fed boss, the central bank has retained its dovish stance despite some members of the committee edging toward the hawkish front.

A year on, the FOMC is decidedly split with doves and hawks on both sides. Wednesday’s meeting for that reason will see market participants assess the language used by the central bank, which in turn, may help to hasten the resolve in answering an even harder question of how rapidly will rates rise after the first hike is announced.