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Breaking down what to expect from Wednesday's FOMC meeting

Deutsche Bank Chief US Economist Matthew Luzzetti joined Yahoo Finance Live to break down what to expect from Wednesday's FOMC meeting.

Video transcript

- In their most recent note to clients, Deutsche Bank said in regards to the upcoming FOMC meeting, which starts tomorrow, quote, "ultimately, with the labor market lagging, no strong evidence that the Fed's transitory inflation story is incorrect."

Let's bring one of the authors of that note into the stream right now. It's always good to have Matthew Luzzetti, Deutsche Bank's chief US economist, joining us. Matthew, it is good to have you here.

We all are concerned about inflation. But you very simply laid it out for us in your note-- not any time soon that the Fed's really going to raise rates. The big discussion is when they start talking about talking about raising rates, right?

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MATTHEW LUZZETTI: Yeah, thanks so much for having me again. I think there's two things we're going to be watching for this week. The first is on the tapering discussions. This is the scaling back of their asset purchases.

And I think that will be the key focus, particularly of the press conference. And there we, and I think most others, expect that the Fed is going to continue to progress these conversations, signal that they have seen some progress in the economy.

Note that they're not going to start tapering, at least right now, but that these conversations are going to continue over the coming meetings and coming months. And they'll continue to assess progress on that front.

I think the second key focus of the meeting will be what's called the Fed's dot plot. This is their own projections where they tell us what's going to happen to interest rates over the next several years. Back in March, they showed no rate hikes through 2023. But there's a risk that it does show a rate hike now in 2023 when they release their updated dots on Wednesday.

We, in a close call, don't think that they will. We think that the labor market lagging, as you noted, we said that the transitory inflation story hasn't been disproven yet. And I think they take some comfort from market moves, both market inflation expectations coming down and the market taking out some of the rate increases that have been built in. So I think it's a close call on that 2023 dot. But our view is that the most likely scenario is that it does not rise on Wednesday.

- So Matthew, you mentioned you expect the Fed to signal some progress. You know that they're not going to taper now, but at least they're going to acknowledge that the conversation is at least starting to take place. Is that enough though? Or is the Fed at risk of really falling behind the eight ball here?

MATTHEW LUZZETTI: Yeah, I think that's the big conversation that we're having in markets right now. We're coming off two very strong inflation prints, both surprising to the upside. There's been some evidence in consumer inflation expectations rising. This morning, we had evidence from the New York Fed. The University of Michigan data did rise, but come back down.

And so there's a real debate, I think, going on in markets about, is the Fed falling behind the curve or not. I think the fact that they're just progressing these conversations, even as the labor market has lagged, I think is an indication that they are a little bit worried about on the inflation front. There is a risk management part to this, which is that, yes, they believe in their transitory story. We agree with them as a base case.

But the risks I think have clearly shifted, and therefore there's risk towards higher inflation going forward. I think that will be a reason to continue down the road of talking about tapering to progress those conversations, even though the labor market has lagged their own expectations and our expectations in recent months.

- And yet, Matthew, the 10-year just can't seem to break out of this range between 1.5 and 2. We had guests on a couple of weeks ago, a couple of months ago, who said by this time we'd be at 2%. And we're just nowhere near it. So what's it telling us?

MATTHEW LUZZETTI: Yeah, I think it's very shocking in a world where we got back-to-back very strong inflation prints. We've had certainly some weaker labor market data. But it's added over 500,000 jobs last month. The economy, we expect, is going to grow 7.7% this year.

So sitting here, looking at a 1.5 10-year treasury yield is a bit surprising. I think it reflects a few things. One, how much expectations were built up for this economy early in the year, both on the inflation front and on the growth front, and how investors became positioned for that. It was just overwhelmingly consensus for higher rates, steeper curbs, higher break-even inflation rates.

And we've just seen some challenges to that narrative. I think, yes, we've seen strong inflation data. But it has been very narrowly focused on a few items. There's been some evidence of the economy not continuing to grow as strongly as may have been expected. We'll get some additional data points there on retail sales tomorrow, which will be an important one.

And then I think on the fiscal front as we look forward, there's been lagging progress on the infrastructure package and expectations for that have come down. So I think those things from a fundamental perspective have also said, we've built in so much into rates market expectations earlier this year, we've had to have a consolidation as we've seen some of this data. And I think things are at least probably better balanced at this point to now respond to both the Fed's messaging and the data that we get in the future.

- Matthew, we also got the Novavax news out today. The vaccine's 90% effective. Taking a look at the market's reaction-- not showing much reaction actually at all to this. But I'm curious to get your perspective from a reopening story, especially on a global scale. How are you looking at this development?

MATTHEW LUZZETTI: Yeah, I think it's maybe surprising. We also got from the UK some delaying of some of the reopening procedures. That I think this is a market-- it's focused in the US, which is just expected to see great growth, great inflation, great labor market data, consumer spending really taking off. And it's been relatively immune, I think, so far to whether it's news on some of the variants that are a little bit more difficult to deal with or some delays in reopening that have been taking place, some of the lagging process in the US on vaccination rates.

So it's a market that has brushed a lot of that aside. And I think as we go forward, if we continue to get some data, but from a labor market perspective and growth perspective that disappoints, we may view risks as being a little bit more balanced on both sides, that there is actually downside risks out there as well, something that we heard from Governor Brainard recently. And so I wouldn't be surprised to hear Chair Powell actually acknowledged some of those facts as well on Wednesday.

- All right always good to see you, Matthew Luzzetti, Deutsche Bank, chief US economist. And just a reminder, Brian Cheung covers the Fed for us. And we'll be covering that meeting on Tuesday and on Wednesday.