The Federal Open Market Committee (FOMC) will meet on Tuesday and Wednesday to determine interest-rate policy. According to the CME's FedWatch, interest-rate futures are pricing in an 87% chance of rates being held at current levels on Wednesday which would maintain the policy rate between 1.50 and 1.75%. There's reason to believe that the market would be disappointed by such an outcome.

Likely to Hold

Odds for rate cuts in future months have increased in recent weeks, specifically as short-term and long-term Treasury yields have moved lower, growth-linked commodities have been declining, and inflation expectations have steeply dropped. In fact, the yield on the 2-year note dropped to 1.44% which is close to its recent low set in October 2019 around 1.40%.

Some Fed-watchers see the spread between the policy rate and the 2-year yield as an expression of the Fed's stimulus. So if the Fed were to hold and the 2-year yield stays below 1.50%, then the Fed's policy is restrictive. If the policy rate is well below the 2-year rate, then it's incentivizing people and institutions to put their money to work.

This is, yet another indication that the "economic growth re-acceleration" thesis is faltering. Recent bullish catalysts have sputtered. These include the Fed's rate cuts, the passage of "phase 1" of the trade deal, and the anticipated bottoming in manufacturing. In the early part of 2019, the economy faced a similar challenge - decelerating economic growth driven by weakness in trade and manufacturing - and the Fed rescued asset markets by cutting rates. This time, although the Fed remains dovish, it may wait for further deterioration before using its ammunition.

FOMC Statement

This is consistent with Chairman Jerome Powell's recent statements that the threshold to cut rates and hike is now higher than it was in the past. The most important part will be the FOMC statement and Chairman Powell's press conference, where he will provide more specifics on what it would take for the Fed to cut further. He's been quite clear that he's not going to hike until inflation is "persistently" above the FOMC's 2% target. This dovish shift was one of the catalysts behind the strength in the final parts of 2019.

Currently, the market sees a weaker economy than the Federal Reserve. It will be interesting to see whether the Fed acknowledges this and that could determine how the meeting is interpreted. Acknowledgement of deterioration and future Fed intervention would be bullish for asset prices and probably lead stocks to recapture previous highs.