FOMC: Four Risks Around a Bland Baseline

Money markets have nothing priced in for the 29 January FOMC, 7bps of cuts for the 19 March meeting, and 25bps cumulatively for H1. We would characterise the Fed’s stance on cuts as ‘show me’. The FOMC would need a visible slowing of activity or inflation to justify resuming a sequence of cuts. We expect both activity and inflation to
slow in H1, but that shift is not yet visible in incoming economic data.

We see four risks from the upcoming meeting:

1. Even a small opening of the door to two-way risk on future policy rate moves would be taken as very hawkish by the market
2. Small tweaks to the FOMC statement may indicate a firming of labour markets
3. Conversely, if Fed Chair Powell echoes Fed Governor Waller’s optimism on disinflation in coming months, markets may add a few bps to March or May rate cut probabilities
4. Any reference to ending or slowing quantitative tightening (QT) could take some pressure off long-end rates, even though it is unclear how much impact QT has had on rates

Of these, (1) would have the biggest market impact, in our view. Even a tiny opening of the door to ‘the next move could be a hike’ could have a major impact on asset markets. Money markets currently price in falling or stable rates through 2027. The possibility of hikes could unwind the residual cutting risk that is now priced in, and even have a few bps of hiking priced for mid-2025. We would expect the yield curve to steepen, the dollar to strengthen and equities to sell off, reversing asset market moves of the last two weeks.