FOMC Preview: Fed Still Needs Better Inflation Data

Summary

• I expect:

• The Fed to keep its easing bias but convey a shallower easing cycle.
• The 2024 median dot to show only one cut and long-term dot to increase.
• Powell to convey strong confidence in growth dynamism.

Market Implications

• I expect the presser to surprise on the hawkish side and still expect no cut in 2024 against market expectations of two cuts.

Data, Politics Drive Greater Fed Hawkishness

The Fed has already implied it would be on hold at its meeting next week. Therefore, the main takeaway will be the guidance. I expect the Fed to keep its easing bias but convey a shallower easing cycle.

Recent Fed communications have turned more hawkish. The minutes of the 1 May FOMC, released 22 May, said:

‘Although monetary policy was seen as restrictive, many participants commented on their uncertainty about the degree of restrictiveness. These participants saw this uncertainty as coming from the possibility that high interest rates may be having smaller effects than in the past, that longer-run equilibrium interest rates may be higher than previously thought, or that the level of potential output may be lower than estimated.’

In addition, the minutes said, ‘Various participants mentioned a willingness to tighten policy further should risks to inflation materialize in a way that such an action became appropriate.’

This was a marked change of tone relative to previous Fedspeak and the 1 May meeting itself. It also came despite a softer April CPI on 15 May. I cannot link the change to a specific data release or event. Rather, it is likely to reflect inflation trends, continued growth dynamism and rising political risks (Charts 1 and 2).

Despite his guilty verdict, former President Trump continues to lead President Biden in the polls and in betting markets. A second Trump administration would raise inflation risks. To preserve policy optionality, the Fed could have decided to move nearer a neutral bias ahead of the 5 November elections.

Median June Dot to Show One 2024 Cut

I expect Chair Powell to communicate that the policy outlook is unchanged but that the Fed needs more ‘good’ inflation prints before it can start cutting. I also expect him to convey strong confidence in the growth outlook. The SEP is therefore likely to show fewer and later cuts than the March SEP.

I expect the SEP core PCE, growth and unemployment forecasts to be roughly unchanged. Unchanged core PCE would reflect current inflation stickiness and that the Fed is confident it can keep inflation on the path envisaged in the March SEP.

Growth could be marked down in 2024 to reflect the downside surprise in Q1, but I expect the longer-term growth trajectory to be little changed.

Unchanged unemployment would reflect that the Fed still believes it can stabilize inflation without raising unemployment.

Because of current inflation stickiness, I expect the dot plot to show fewer cuts:

• 2024 dot: one cut, compared with three in the March SEP, and a narrower distribution. This is based on recent Fedspeak suggesting most FOMC members could join Chair Powell for one 2024 cut, four hawks could show no cut, and three doves to show two 2024 cuts (Chart 3; Table 1).
• 2025 dot: four cuts compared with three in the March SEP. I expect the 2025 dot to be 25bp higher than in the March SEP to reflect inflation is turning out more stubborn than expected.
• 2026: four cuts, leaving the 2026 dot unchanged. This would reflect the Fed confidence in the long-term FFR trajectory
• The long-term dot to increase further in line with Fedspeak, for instance to 2.9% from 2.6% in the March SEP.

Market Consequences

I still expect no cut in 2024, based on my forecast that core PCE will remain stuck around 3%, against markets pricing two cuts by December. I also expect the presser to surprise on the hawkish side.

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Dominique Dwor-Frecaut is a macro strategist based in Southern California. She has worked on EM and DMs at hedge funds, on the sell side, the NY Fed , the IMF and the World Bank. She publishes the blog Macro Sis that discusses the drivers of macro returns.

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(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)