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Fed Readies First Rate Hike Since 2018; But 'Soft Landing' Challenge May Prove More Difficult

Fed Chairman Jerome Powell has managed to keep an impatient market waiting for the first Fed rate hike since 2018, but executing a 'soft landing' for the world's biggest economy may prove to be far more difficult.

The Federal Reserve is almost certain to unveil its first rate hike since December of 2018 Wednesday, as the central bank responds to a series of the fastest inflation readings in four decades, plunging unemployment and stable growth forecasts.

The CME Group's FedWatch tool sees a 98.3% chance of the Fed lifting its base rate to between 0.25% and 0.5% this afternoon, with bets now set on how many further hikes the economy -- which is slowing notably but its still expanding -- can withstand throughout the rest of the year as inflation continues to surge.

Powell told lawmakers on Capitol Hill last week that the Fed can execute a so-called 'soft landing' for the world's biggest economy, "which is get inflation back under control without a recession", but that task has become even more difficult now that the ongoing war in Ukraine is holding energy prices near their highest levels on record and China's recent Covid infection spike threatens to extend supply chain disruptions through to the end of the year.

"Chair Powell doubtless will say that the Fed is alert to the dangers posed by the war in Ukraine and the accompanying surge in energy prices, and is prepared to change tack if the economic data deteriorate sharply or financial conditions tighten materially," said Ian Shepherdson of Pantheon Macroeconomics. "But the Fed's base case for this year likely will shift from the three hikes projected at the December meeting to five, and we would not be much surprised by six."

The Fed is also likely to punt on winding down its $8.9 trillion balance sheet, but will issue new economic projections for 2022 that are likely to reflect that energy-price and supply chain-driven slowdown captured by the Atlanta Fed's GDPNow forecasting tool, which currently shows the economy growing at a 0.5% clip.

"The last time the Fed shrank its balance sheet beginning in 2018, it began at a monthly pace of $10 billion and peaked at $50 billion,: said John Lynch, chief investment officer at Comerica Wealth Management. "Most Fed watchers expect a quicker pace this time around."

But would the Fed be willing to add additional tightening -- in the form of a balance sheet run-off, which would raise market interest rates alongside its Fed Funds rate -- while the economy adapts to record-high gas prices, surging inflation and fading government stimulus?

U.S. consumer confidence hit a ten-year low this month, according to the University of Michigan's closely-tracked data set, amid the energy price surge triggered by Russia's invasion of Ukraine on February 24.

"The last time U.S. consumer confidence was this low, Congress intervened by passing the Cares Act, sending direct stimulus payments to millions of Americans and expanding unemployment insurance benefits," said Morning Consult chief economist John Leer, who runs his own consumer sentiment data index. "Congress is unlikely to be of much help this time around."

"Monetary policy is the primary tool to combat inflation," he added. The Fed faces a delicate balancing act to achieve a soft landing. It wants to raise rates to fight inflation, but it doesn’t want to prematurely end the recovery."