This Wednesday FOMC rate decision at 19.00GMT/14.00ET. Presser at 19.30GMT/14.30ET

JPM: JPM economists expect the FOMC will use the January meeting statement to signal the high likelihood of a rate hike at the subsequent meeting in mid-March. They also look for the Fed to continue to taper down asset purchases at the pace determined at the December meeting. There is a risk (perhaps one-in-four) that the Fed completely ceases purchasing assets in mid-February. The odds of a surprise rate hike this week look much smaller, in JPM’s view.

– There will be no dots or SEP updates at the January meeting. JPM’s economists note that this leaves plenty of space for the Committee to cement in place expectations

that policy will be tightened at the following meeting. The December FOMC statement noted that the Fed’s inflation conditions for liftoff have been met. JPM expect this week’s statement will add that the maximum employment condition is close to being met and that the Committee anticipates that it will soon be appropriate to adjust the stance of policy. In December, the statement dropped guidance on the pace of tightening after liftoff (i.e. “expects to maintain an accommodative stance…”) and they don’t expect any such guidance to come back next week. Some might see this as opening the door to a 50bp hike in March, but JPM think the more likely use of this flexibility is the option to hike at every meeting, if the need arises

– As for the sunsetting asset purchases, the December FOMC meeting determined the pace of purchases through mid-February, and the consensus expectation for next

week is that from mid-February to mid-March, the Fed will purchase $30 billion in assets and cease purchases at the end of that period. A case could be made for the Fed to stop short and cease asset purchases in mid-February. While this may have merit, the Powell Fed has been loath to shock markets on meeting days, preferring to signal any pivots in speeches and media reports. No such signal was given leading up to this week’s meeting.

– Last but not least, JPM economists don’t expect the statement to address balance sheet normalization plans. However, if the Committee agrees on a plan this week, then they would expect this to be communicated in Powell’s opening remarks

GS: The FOMC is likely to use its January meeting next week to hint at a March liftoff and to begin formulating a plan for balance sheet reduction. GS expect the FOMC to raise interest rates four times this year starting in March and to announce the start of balance sheet reduction in July.

– Two recent developments have made us more concerned about the inflation outlook. First, Omicron could prolong supply-demand imbalances and delay price normalization in the goods sector. Second, wage growth is still running at a 5-6% annualized pace months after enhanced unemployment benefits expired. In coming months, the inflation dashboard is likely to show lingering supply chain problems, hot wage growth, strong rent growth, very high year-on-year core PCE and especially core CPI inflation, and very high short-term inflation expectations.

– GS see a risk that the FOMC will want to take some tightening action at every meeting until that picture changes. This raises the possibility of a hike or an earlier balance sheet announcement in May, and of more than four hikes this year. The limited tightening in financial conditions so far, if sustained, would lower the bar for hiking more than the four times the market has already priced. If Fed officials do decide that they need to be more aggressive, they would likely hike by 25bp at consecutive meetings rather than hike by 50bp. Even that would be a major step, and few Fed officials appear to be considering it for now.

– GS have revised their Fed scenario analysis to reflect this possibility of faster rate hikes in response to higher inflation. The probabilities they assign to possible paths for the funds rate imply that the risks are tilted somewhat to the upside of their baseline and that their views remain more hawkish than market pricing.

Balance sheet reduction is likely to be quicker than last cycle, mainly because there is much further to go. GS expect peak runoff caps of $60bn per month for Treasury securities and $40bn per month for mortgage-backed securities, or $100bn total, with at most a brief ramp-up period. GS project that this would shrink the balance sheet from $8.8tn today to $6.1-6.6tn over 2-2.5 years. Their analysis implies that this amount of balance sheet reduction would raise 10y Treasury yields by 30bp, though some of this is likely already priced, and would have roughly the same impact on the economy as a 30bp rate hike.

Citi: The focus point will be on asset purchases, balance sheet, and hints on the rate hike schedule. In Citi Economics’ base case the committee will continue tapering through March, though it would not be too surprising (for us or markets) to see an early end announced in January. Fed Chair Powell should continue to suggest balance sheet reductions will happen “later this year” (though more clarity is expected in the minutes on February 16).

MS: MS see the Fed delivering its first of four 25bp rate hikes this year at its March meeting, then announcing a more aggressive runoff of its balance sheet in July.

• At its January meeting, MS expect the Fed to signal a March hike with a key change in the statement that, “if labor market progress continues broadly as expected, the Committee judges that an increase in the federal funds rate may soon be warranted.”

• With an aim toward preserving maximum flexibility, Chair Powell avoids committing to a “gradual” or “measured” pace by stressing that every meeting is live. The Committee’s view on how to proceed with plans to begin reducing the size of the SOMA portfolio will dominate deliberations with additional details provided in the minutes, three weeks later.

• With an underpriced terminal rate and impending Treasury supply impact from QT, MS’ strategists stay positioned for belly underperformance into the January FOMC meeting via (1) 5s30s flatteners and (2) 2s5s steepeners vs. long 30s (DV01 ratio 0.76 : 1). They maintain views for higher real yields via (3) short 5y TIPS vs. DBRis and (4) short 5y TIPS vs. EDZ3 (Dv01 ratio 0.8 : 1.0).

• MS’ FX strategists continue to recommend long USD/JPY positions as US yields rise, but see broad USD gains limited by stretched long USD positioning and an improving outlook abroad. Their Agency MBS strategists maintain their short FNCL 3.0 and 15yr 2.5 vs. entire yield curve and long specified pools vs. TBA trades

NWM: No action on rates is expected, however, market participants will look to any substantive changes to the statement, particularly in the treatment of the policy outlook.

In NWM’s view, the statement will mostly mark time and suggest that economic conditions have not changed materially from December. However, the FOMC could plant a hint about the March policy outlook in the January statement. The most obvious development at the March meeting will be the ending of QE, as pre-announced, but markets are also pricing in a high probability of liftoff to be announced in March too, and at his recent congressional testimony Powell for the most part seemed to validate this expectation. (NWM expect a 25 bps rate hike in March and two additional hikes later in the year: June and December, with balance sheet contraction—i.e., QT to start at the September meeting.) Admittedly, at his January 11 re-nomination hearing, Fed Chairman Powell did not send an explicit signal on when tightening will start, noting that, “the committee hasn’t made any decisions about the timing of any of that, and I think we’re going to have to be both humble and a bit nimble here.” However, he did say that “It is really time for us to move away from those emergency pandemic settings to a more normal level” and added in that “if things have developed as expected we’ll be normalizing policy, meaning we’re going to end our asset purchases in March, meaning we’ll be raising rates over the course of the year. At some point, perhaps later this year, we will start to allow the balance sheet to runoff.” While it is debatable whether or not Fed officials “prep the market” by providing explicit guidance on the expected timing of liftoff, NWM suspect the FOMC could slip a hawkish hint into the statement (bolstering recent Fedspeak and market expectations) that the March meeting is the base case for the start of normalization