The Fed is widely expected to keep rates steady at 4.25% – 4.50% on Wednesday amid an uncertain environment, now contending with a conflict in the Middle East. That looks to be relatively localised at the time of writing, with markets assuming the Strait of Hormuz will be unaffected, though low probability, high impact outcomes must not be ignored. In fact, the energy market volatility could be an argument for rate setters to fend off President Trump and his calls for interest rate cuts, as it gives the Fed more reason to assess the impact from both those geopolitical concerns and tariffs on the economic outlook.
Fed officials have consistently stated they will be patient in watching and analysing the impact of trade policy and tariffs on growth and inflation. This uncertainty and actual policy are predicted to take some months to feed properly into economic data which means the Fed will stay in ‘wait-and-see’ mode for the foreseeable future.
Updated dot plot and economic projections
The key focus for markets at this meeting will be the release of the updated Fed forecasts and fabled dot plot. The most recent median dot in March predicted two 25bps rates cuts in both 2025 and 2026. This remains roughly in line with current market pricing, so it seems probable that officials stick with this. However, the hawkish risk is that rate cuts are delayed so the median dot points to just one quarter-point move this year and 75bps next year.
Quite sizeable downward revisions are possible to GDP forecasts due to the post-Liberation Day tariff impact. But core PCE inflation forecast could shift higher for 2025 with the latest shock of geopolitical uncertainty blurring the outlook. This all suggests stagflation is in play, with stagnant, softer growth and rising price pressures. The jobless rate will likely remain steady as tighter immigration offsets slower hiring.
The Fed’s assessment on the balance of risks will also be watched closely. Back in March, FOMC officials reported that inflation risks had become increasingly skewed to the topside, but that GDP and unemployment risks were better balanced. More recently, Chair Powell stated that both growth and inflation uncertainty had increased, but he avoided specifying which risk felt more pressing at the time. As long as there are no big cracks in the labour market, it is assumed policymakers will be wary of inflation challenges in the near term, with growth issues potentially further out.
Market reaction
Money markets are now pricing in around 47bps of policy easing for this year. Traders currently price in around a 65% chance of the next 25bps rate cut at the September meeting and less than a 15% bet on a July move. With little strong guidance from Powell expected, risks could be tilted to lower rates and so further dollar weakness if the FOMC gives any signal of policy easing ahead.
The dollar normally moves in line with short-dated US yields, but a more hawkish Fed may not be enough to keep the greenback bid in the current environment as the bias remains bearish with upticks sold into. The major three-year low on the Dollar Index remains at 97.92, with little strong long-term support below.