In December, when Jerome Powell donned the "hawk hat" at the FOMC meeting, the markets went down sharply. The S&P 500 dropped 3% in a matter of hours due to tightening financial conditions.
Source
The reason was a shift in the "dot plot" — instead of the four expected rate cuts in 2025, the Fed indicated only two. This added to the nervousness, and Powell expressed concerns about inflation. At one point, the markets even envisioned just one rate cut for 2025.
Today, the market has calmed down: now prices include from one to two rate cuts next year.
What to expect at this meeting?
Everyone knows that the Fed will almost certainly keep rates at the current level (91% forecast). The main question is, what signals will Powell send? Will he continue to be as hawkish as he was in December?
It's hard to believe that Powell will get tougher. The inflation data after the December FOMC turned out to be slightly better than expected. The decrease in inflation in the housing sector is particularly noticeable. However, there are also "hot spots": some price data show an increase. The picture is mixed, but far from critical.
Most likely, the Fed's neutral attitude awaits us — without surprises and harsh statements. But if there are hints of more rate cuts in 2025 or the start of them in the summer, this will be a strong driver for the growth of risky assets.
Key factors: QT and liquidity shortage
Another important point is the policy of quantitative tightening (QT). We have seen signs of tension in the dollar funding markets in recent quarters. For example, the SOFR rate has risen above the Fed's rate range, which indicates problems with liquidity.
These difficulties are related to the reduction of banks' reserves. The level of reserves in December dropped to the lowest levels since 2020. The Fed is striving to keep reserves "sufficient," but QT is putting pressure on their reduction.
Most likely, QT will not be stopped yet. The Fed usually warns about such changes in advance. But it's worth keeping an eye on the signals, especially if journalists raise the topic of liquidity and reserves at a press conference.
Conclusions
Powell is likely to speak more cautiously this week than in December. And if there is even a hint of an acceleration in rate cuts or a weakening of QT, this will be a powerful incentive for the growth of markets. However, such changes are unlikely to happen now — the Fed usually acts slowly and consistently.
However, there is still a small chance of a "surprise", since this is the first meeting after Trump took office, and he insists lower rates and a weaker dollar.
This is a time for investors to remain flexible and keep a close eye on Powell's words. If a rally of risky assets begins, it will be fast and strong.