It could be a volatile few hours coming up as markets face the latest release of the US inflation data, and then, a few hours later, the FOMC meeting. Policymakers will keep its rates unchanged, but what they say in their new dot plot, a guestimate of where they think rates will be at the end of the year, will be crucial in framing market expectations for the coming months. The central bank is likely to want to see more progress on the inflation front before easing policy.
The good news for rate setters is that April’s CPI and PCE data came in line with market forecasts. In fact, the outcome provided a reprieve for the market following a re-acceleration in services inflation during the first three months of 2024. Of course, one month does not make a trend, but it certainly can start one. For May, headline CPI is expected to rise by 0.2% m/m, one-tenth lower than the previous 0.3%, so 3.4% y/y, while the core rate is again expected to remain unchanged at 0.3% m/m, and 3.5% y/y.
Further disinflation needed
It is critically important for market expectations that May shows further evidence of disinflation towards the 2% medium-term target. Prices for core services and housing services will be closely watched, with services inflation the area that is keeping headline inflation sticky.
Helping in May will be the reversal in oil’s first quarter 2024 gains. Core inflation is also likely to show evidence of progress. Some of the strong subcomponents are expected to plateau, and shelter, which holds a big weighting in the basket, is seen decelerating further. It is important to remember that excluding shelter, annual inflation is already back at the Fed’s goal.
Existing forward guidance likely to be kept
The FOMC will leave rates unchanged at between 5.25-5.50% in June for a seventh straight meeting. In each of the policy statements issued so far this year, the Fed has said it “does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably towards 2 percent.” This key piece of forward guidance is expected to be retained in June. In May, Fed Chair Jerome Powell emphasized that the inflation data so far in 2024 had not provided the policymakers with that “greater confidence”, although he said the Fed had made real progress on the prices front. He urged patience, and to allow time for policy to do its work, adding that restrictive policy may take longer than expected to impact materially.
New Quarterly Dot Plot Crucial
As is normal four times a year, the focus will be on the Summary of Economic Projections (SEP) and key will be the FOMC’s median assessment for the appropriate Fed Funds rate at end of 2024 ie. how many rate cuts the Fed is pencilling in this year (aka the dot plot). The March forecasts narrowly projected three rate cuts this year, but there is a strong likelihood the updated projections could reduce that view to just two moves or even fewer. That means the 2024 median dot should move higher to imply either 25bps or 50bps in rate cuts this year.
As for growth and inflation forecasts, in the March SEP, the Fed projected that headline PCE inflation will fall to 2.4% y/y this year, while core PCE was seen falling to 2.6% y/y this year (for reference, the April data printed 2.7% and 2.8% respectively). The SEP did not see inflation returning to the Fed’s 2% target until 2026. That means the Fed could be raising its inflation forecast modestly and possibly growth, though significant changes are not predicted.
Watchwords and hike question?
The watchwords for the meeting are expected to be “patience” and needing “confidence” on the inflation front for Fed officials to kick off any policy easing. Powell may put greater emphasis on the risks to the outlook as upside risks to inflation fade, while downside risks for employment and activity grow.
He will likely again bat away suggestions of a hike, though questioning in his press conference especially, could be interesting after the most recent big upside surprise in the monthly US non-farm payrolls data where wage growth picked up too. That said, the Fed has been focused on the jobless rate, which hit 4% for the first time since January 2022 while the economy is certainly not overheating.
Market reaction
Markets are pricing around 35bps of rate cuts through the end of this year, with the first cut now not fully priced in until December. A September 25bps rate reduction is now a coin toss, after being as high as 80% in recent weeks.
The dollar will react sharply to a more hawkish hold and a median dot plot that shows one rate cut. That said, forward-looking data is subdued and any softness in services CPI which is released a few hours before the FOMC could help September rate cuts bets and hurt the greenback. We note that USD has finished lower on the day after the last four straight FOMC meetings. That has been largely due to Powell’s dovish rhetoric at his press conference, with consensus generally thinking that continues.
