FOMC likely to soften its forward guidance, still signal some further policy rate firming needed: Barclays Research

The Federal Open Market Committee (FOMC) is expected to soften its forward guidance, yet still signal that it believes some further policy rate firming will likely be needed, given the shift in tone from FOMC participants following the December meeting, according to the latest report from Barclays Research.

Further, the monetary policy committee is expected to describe economic activity as growing at a “solid” pace as opposed to “strong.” The November and December minutes contain fewer uses of the word “strong” than those from August and September, and the number is likely to decline further in January. If so, then a modest downgrade in the assessment of the data flow may be at hand.

Also, the statement is expected to note the decline in market-based measures of inflation compensation. The failure to do so in December may have been a mistake, as it fuelled market concerns that the Fed was on a path to over-tighten.

Many FOMC participants have tied their desire to be patient to below-target inflation, and acknowledging the decline in inflation compensation reinforces this message.

In the press conference, Chairman Powell will likely need to address outcomes that would cause the Fed to slow or stop balance sheet runoff. In our view, he will emphasise that interest rate policy is the primary tool to fine-tune the policy stance, but that the committee would be prepared to alter its balance sheet policies if a major deterioration in the outlook were at hand.

"We look for the Fed to update its policy normalization principles and plans from 2014 to reflect acceptance of its post-crisis operating framework (eg, IOER, RRP, large balance sheet, Treasury-only portfolio), as opposed to its pre-crisis framework of interest rate control based on de minimis reserve balances and open market operations. We think the chairman could announce this in the post-meeting press conference and release the updated principles and plans alongside his post-meeting statement. This decision, in our view, is long overdue," the report commented.