Today is the day investors have been anticipating for a long time. This afternoon, we will see the release of the U.S. inflation report, followed by the Federal Reserve’s decision and the latest forecasts in the evening, along with Powell’s participation in a post-meeting press conference. Yesterday’s session ended with gains in the SP500 and Nasdaq Composite, up 0.3% and 0.9%, respectively. The Dow Jones performed worse, losing 0.3%. The dollar gained slightly, with the EUR/USD exchange rate falling below 1.0725. After a dynamic rise in U.S. bond yields last Friday due to the NFP report, they have slightly declined this week, with 2-year yields at 4.85%.
Today, the U.S. Federal Reserve is expected to maintain interest rates at the current level of 5.25-5.5%. September might be indicated as the first possible occasion for a serious consideration of lowering the cost of money. The implied probability of such a scenario, as indicated by Fed Funds futures contracts, is currently around 50%.
The main focus will be on the updated dot plot. In March, the median expectations of FOMC members indicated three rate cuts of 25 basis points each. Since April, the market has doubted this scenario, expecting a maximum of two or even one rate cut. Regarding 2025, recent projections also indicated three downward steps of similar values. A more significant dollar strengthening move will occur if the latest dot chart indicates one change or no change this year. If the median suggests two cuts by December, the USD appreciation rally may be limited, as the market has largely already discounted this change in the perceived future path of rates by U.S. policymakers.
Opinions regarding the start and dynamics of the monetary easing cycle in the U.S. vary, likely due to significant uncertainty about economic and inflation trends. So, what are the data from recent weeks showing? Inflation has significantly decreased from its peak, but this year, the trend has stalled, and some measures have “ticked up,” such as the PCE deflator. In April, it was 2.7%, with the core at 2.8%—well above the Fed’s target. Today’s data at 14:30 is expected to show the main CPI indicator stabilizing at 3.4% and the core CPI slightly declining from 3.6% to 3.5%. This afternoon’s publication may additionally shape Powell’s rhetoric during the press conference.
Meanwhile, U.S. economic growth has weakened. However, there are no clear signs of a recession. The labor market shows initial signs of cooling, but it remains stable, as evidenced by the recent monthly report indicating the creation of 272,000 new non-farm jobs. Macro data are still too strong to justify a rate cut in the near future. There is a good chance that the Fed will revise its forecasts for inflation and economic growth upwards, and if so, the words of the Federal Reserve Chairman may sound “hawkish.”
The Federal Reserve does not want to trigger a recession but wants to see stronger effects from its past actions. For rate cuts to occur, the Fed needs more arguments indicating easing inflationary pressures, cooling in the labor market, and weakening consumer spending. Therefore, a few more CPI/PCE readings are needed to show that the disinflationary trend (which temporarily stalled in Q1) is continuing. The increase in the unemployment rate from 3.9% to 4.0% (seen recently) is insufficient to assume a significant deterioration. Job creation should approach approximately 100,000, and wage growth dynamics should decrease. Friday’s NFP report showed an increase both on a monthly and yearly basis. Additionally, the recent U.S. GDP revision provided evidence of weakening consumer strength, confirmed by weak spending data in April. This situation is likely to worsen, suggesting flat real income growth for U.S. households and the depletion of pandemic-era savings. Moreover, the Fed’s restrictive monetary policy in recent months is already taking its toll with rising credit delinquencies.
Łukasz Zembik, Oanda TMS Brokers
