Think higher inflation is coming? The Fed will believe it when it sees it

Think higher inflation is coming? The Fed will believe it when it sees it

Federal Reserve officials will meet this week just as prospects for fiscal stimulus get a big boost after Democrats won control the Senate.

Some on Wall Street are talking about higher growth and higher inflation. Color the Fed skeptical.

Economists don’t expect Fed Chairman Jerome Powell to change his dovish message at all.

“Fed officials have been reluctant to upgrade the outlook and most have adopted an ‘I’ll-believe-it-when-I-see-it’ attitude,” said Aneta Markowska, chief economist at Jefferies, in a note to clients.

Powell will meet with reporters at 2:30 p.m. Eastern on Wednesday after the Fed releases a policy statement at 2:00.

Powell’s remarks are expected to be the highlight for investors as the statement is expected to be little changed. The Fed won’t release updated economic projections until its March 16-17 meeting.

In a comment echoed by many Fed watchers, Jim O’Sullivan, chief U.S. macro strategist for TD Securities, said he expects Powell to be quite dovish on monetary policy at his press conference even if he agrees there are reasons to believe growth should be fairly strong later this year.

“We expect Powell to emphasize that inflation will be key to when the Fed exit begins, and most Fed officials are skeptical that a few strong quarters of growth will suddenly lead to a meaningful pickup in the trend of inflation,” O’Sullivan said.

A pickup in inflation would be a win for the Fed. Central banks around the world are grappling with disinflation, which is pushing down interest rates and growth prospects.

The Fed has been buying $120 billion per month of Treasurys and mortgage-backed securities to keep financial conditions tame and boost the economy.

At its last meeting, the Fed said it would maintain the purchases until there has been “substantial further progress” has been made on the Fed’s goals of low unemployment and stable 2% inflation.

Over the past six weeks, some Fed officials have speculated that tapering the purchases could happen this year.

In response, Powell told a Princeton University web conference it was premature to talk about exit. He also argued that inflation might spike briefly, but was not likely to be persistent.

The Fed chairman wants to make it clear to the market that the Fed doesn’t intend to tighten prematurely, said Lou Crandall, chief economist at Wrightson ICAP.

“The best way to persuade the market that the FOMC won’t be trigger-happy about raising rates down the road is to be conspicuously patient about launching its quantitative-easing wind-down,” Crandall said.

Fed officials recognize that there are potential financial stability risks in this monetary policy environment.

Cleveland Fed President Loretta Mester told reporters earlier this month that she didn’t see “risks underlying the financial system right now as being excessive in any sense.” She added that she would continue to monitor the sector.

The yield on the 10-year Treasury note

has risen 0.127 percentage points since the last Fed meeting in mid-December.

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