Today is the FOMC day, as markets brace for the decisions. Market expectations for this FOMC meeting have changed dramatically in the past months. At the beginning of March, implied Fed funds futures were 5.35% for this meeting. This changed to 4.82% at the start of April and 5.13% at the beginning of May. After a roller coaster of expectations in recent months, the final expectation is for the Fed to hold rates for this meeting with an 86% probability, and to hike 25 basis points in the next two meetings with an 81% probability. After yesterday’s CPI data, the final expectation seems very rational in our opinion. Inflation fell to 4% from 4.9% in May on a year-on-year basis, marking 11 consecutive months of decline. However, core inflation is still holding strong, even after yesterday’s decline, at 5.3%. The data shows both positives and negatives. Since 2021, services have been the main contributor to inflation. Now, super core services inflation is showing a possible downtrend. Unless there is an additional contribution from goods, which is unlikely in the short term due to weak ISM manufacturing data, the downward trend in inflation might continue.
However, when looking at the monthly data, core inflation remains at the 2-year average of 0.4% and shows no sign of slowing down. If we assume this average holds, it would mean core inflation of more than 4.9% for the next 12 months, which is more than double the Fed’s inflation target. While the year-on-year data shows some improvement, the month-on-month data tells a different story.
In light of the new inflation data, FOMC members are likely to pass this meeting without implementing any rate hikes. The question then becomes what decisions will be made in the next meetings. To assess that, there are four key points to watch today.
The first point is the FOMC statement. How hawkish the statement will be, and whether there will be a sentence indicating the necessity of “additional policy firming,” could tip the markets.
The second point to consider is the dot plot and forecast table, where members project the rates at the end of the year and in the following years. Any upward revision to inflation and rate forecasts will have an impact on markets. We anticipate an upward revision to inflation and rate forecasts. Additionally, the GDP forecast will be important as well. In the past two FOMC minutes, the Fed staff projected a recession, while FOMC members did not. But this outlook can change with the possible upward revision to inflation and Fed rates.
The third point is the presence of dissidents. For some time now, decisions have been made without any dissents. If the Fed does not hike rates today and there are dissidents, it could indicate that some members are not satisfied with the current level of rates.
Finally, the press conference will be significant, as Powell will adjust market expectations for the next meetings and attempt to smooth market reactions, as usual.
As the FOMC meeting approaches, the dollar index appears uncertain about which direction to take. There is a possible falling wedge formation, a potential shorter-term downtrend, with the Fibonacci 23.6% retracement level converging around the 103-104 zone. Despite some upward testing, there has not been a clear breakout yet, which currently favors the dollar bears. If there is no breakout, the index might start to fall towards the 100.85 support in the coming days once again.
In the event of an upward breakout of the 103-104 zone, the next target could be 105.75. This level is crucial as it has served as both support and resistance multiple times over the past two years. This resistance level could impede any further extension of a potential dollar rally.
