This is the big question facing financial markets today – aside from ‘What will Putin do in Ukraine?’ of course. The latter is part of the mix in the pot that the Fed is watching, with inflation, Covid risk, China slowdown risk, house price risks and of course, why is everybody leaving their jobs and what will it take to bring them back, all part of the January angst so far. The Fed could do what many (it seems) economists have been arguing for in print and other media – lay out a relatively hawkish rate hike trajectory and detail a quick move to start to reduce their balance sheet bond holdings (quantitative tightening, as Trump moaned about).
The thing is, while keeping rocketing price pressures and a reduced unemployment rate in mind, sentiment matters to the Fed. They will have noted the 10%+ drawdown from recent peaks in many US stock indices. The Fed could note that the Tesla founder dumped a truckload of shares on the market and blame him of course, but odds are they will take a more nuanced view and say to themselves ‘investors are really spooked and if Wall St. woes spread to Main St., we have a problem’. This may prompt them to remind the markets today that they are not robots and rate hike trajectory projections from the ‘dot-plot’ guesses are not set in stone.
Fed Chair Powell may remind the market that they are data dependent, and flattening yield curves and tumbling stock markets are part of their data set. This will push back on the view that the Fed will raise rates regardless of what happens in stock markets, while staying away from a guaranteed Fed put. The mess that Fed Chair Powell made in 2018 is probably still fresh in his mind and he may seek to avoid policy signalling mistakes.