As the Fed gets closer to completing their rate hiking cycle, the market reaction should become relatively more muted. (ddp)

First, they can change the wording of the FOMC statement. The November statement said that “The Committee anticipates that ongoing increases in the target range will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time.” We think that it’s too soon for the Fed to declare an end to the rate hiking cycle, and this wording is likely to be maintained.

Second, the FOMC will provide an update of their Summary of Economic Projections for the first time since September. Fed Chair Powell has been hinting that the “dots,” which indicate where FOMC members expect rates to be at the end of each calendar year, will be raised from September’s levels. Despite the recent more favorable inflation data, we expect the dots to indicate another 50-75 bps of rate hikes in 2023, bringing rates to the vicinity of 5%. Markets will also look at the dots for 2024 and 2025 to get a sense of how quickly the Fed might lower rates once rate cuts start.

Third, Powell can use his post-meeting press conference. Even after today’s lower-than-expected CPI print, we do not expect much change in that message. Inflation appears to be slowing and Powell should welcome this news, but as he has said repeatedly, wage growth remains too rapid to be compatible with the Fed’s 2% target. Just last week, the Atlanta Fed Wage Growth Tracker showed wages up 6.4% year-over-year, way above the 3.5% level in the pre-pandemic period. There will be pressure on the Fed to continue raising rates until there are clear signs that the labor market is softening. In particular, Powell has talked a lot about the gap between job openings and unemployed workers available to fill them. Further, Powell will likely reiterate that the Fed does not intend to start cutting rates anytime soon. They want to make sure that inflation will stay low in the future by keeping rates in restrictive territory for some time.

Markets have been very sensitive to Fed meetings this year—with sharp moves in either direction often taking shape during the press conference. But as the Fed gets closer to completing their rate hiking cycle, the market reaction should become relatively more muted. And more importantly, regardless of the initial reaction, we believe the broader Fed narrative will likely remain the same. The Fed may be slowing their pace of rate hikes from 50bp down to 25bp in 2023, but they are still several months away from pausing, and even further from a pivot. And given stocks don’t typically see a turning point until rate cuts are on the horizon, we still don’t believe a sustained rally is likely over the next three to six months. With the risk-reward tradeoff still unfavorable in our view, we continue to favor defensive assets.

Read the original report FOMC preview: What to expect 13 December 2022.

Main contributors: Solita Marcelli and Brian Rose

This content is a product of the UBS Chief Investment Office.