Jerome Powell needs to answer one key question as the Fed prepares to raise rates again

Reuters/Joshua Roberts

Jerome Powell testifies before the Senate Banking, Housing and Urban Affairs Committee on his nomination to become chairman of the U.S. Federal Reserve in Washington, U.S., November 28, 2017.

• With markets fully pricing in another Federal Reserve interest rate rise at this week's meeting, all eyes will be on the central bank's hints into the pace and quantity of future hikes.
• Fed Chairman Jerome Powell will need to answer the key question of recent trade tensions, combined with economic turbulence ranging from Europe to emerging markets, has dimmed the Fed's domestic outlook.
• Powell will likely remain optimistic, but non-committal regarding the pace of hikes beyond September.

There's one key question facing Fed Chairman Jerome Powell.

Has the Federal Reserve's optimism about future economic growth, predicated in part on some expected fiscal boost from the tax cuts, waned in the face of rising global trade tensions and emerging market turbulence?

Pretty much all of Wall Street is forecasting another interest rate increase from this week after the US jobless rate fell to a an 18-year low 3.8%.

But what really matters for investors now is the likely pace and quantity of future rate hikes beyond Wednesday's announcement - which will take the federal funds target range up by a quarter percentage point to 1.75%-2.0%.

The latest economic data show inflation picking up in line with the recent spike in oil prices, but workers' wages still failing to keep up.

Markets are especially fixated on whether or not the Fed will raise rates a fourth time at the end of the year, or hold off on additional increases until 2019.

The messaging is everything, and that includes the Fed's post-meeting statement, the central bank's new round of economic and rate forecasts and Fed Chairman Jerome Powell's quarterly press conference.

Chances are, Powell will stick to an optimistic script, downplaying trade concerns as too early to have a concrete economic impact as he did in recent congressional testimony.

Rate Neutrality

Another key concern for investors is the Fed's "terminal rate" - where policymakers believe the federal funds rate will end up. All indications are that the expected "neutral rate," one that neither boosts or retards economic growth, has fallen since the Great Recession. Currently, the median projection for that longer-run rate is 2.9%.

In assessing the Fed's outlook for the longer-run federal funds rate, Wall Street economists are focused on language in the policy statement that says the rate "is likely to remain, for some time, below levels that are expected to prevail in the longer run."

Fed Governor Brainard suggested this language was "stale" in a recent speech. Investors are quite curious as to whether Powell will want to echo such remarks in advance of a change or be willing to execute it as early as this meeting.

"Her argument looks reasonable and suggests some sense of urgency to revise the language," writes economist Lewis Alexander and his colleagues at Nomura in a research note. "Against this backdrop, we expect that the Committee will likely drop this forward guidance sentence from the statement without a replacement, consistent with the trend after Chair Powell was sworn in to simplify the Fed's communication."

Moreover, they add, the Fed will have to account for a visible deterioration of the outlook for growth overseas.

Brainard "acknowledged that 'recent developments abroad suggest some risk to the downside,' indicating that Powell's language at the March press conference that 'foreign growth is on a firm trajectory,' will likely be updated," the Nomura economists concluded.