News & analysis

The Federal Reserve unanimously kept its target range for the Federal funds rate on hold at 5.25-5.5% today. Moreover, the latest policy statement contained very little updates.

Outside of removing its guidance about tapering its quantitative tightening programme, which is now already underway, the only change in language occurred in the characterisation of inflation, which policymakers now deem to have made “modest” instead of a “lack of” progress. As a result, it was the FOMC’s updated economic projections that garnered the market’s attention. In response to the dramatic improvement in the inflation data earlier today, there has been a lot of speculation regarding the degree to which FOMC members adjust their forecasts, with the data point offering a notable counterpoint to the strong payrolls reading earlier in the month. However, as we warned in our response to the May CPI report earlier, the Fed didn’t take too much confidence from just one inflation reading, having previously discounted two inflation reports as insufficient to extract a signal back in March. This was confirmed by Chair Powell, who stated that the vast majority of the FOMC kept their projections unchanged despite today’s data.

Instead, with the labour market remaining strong and in need of further easing for Fed members to gain greater confidence, as per their updated forecasts of the unemployment rate, policymakers revised up their expectations for rates.

The median projection now implies just one cut as their base case this year, followed by four in 2025 and 2026. This is notably more hawkish than March’s projections, where the median dot projected three rate cuts in each year over the next three years. Moreover, the balance of risks also skewed in a hawkish direction, with four policymakers now anticipating no cuts this year, up from just two back in March, with the mean projection rising across the entire forecast horizon. While Chair Powell once again downplayed the significance of the Fed’s dot plot in the press conference, stating the FOMC will “let the data light the way”, his focus on the level of data uncertainty combined with the upshift in the Fed’s projected rate path to take some of the steam out of the post-CPI risk rally.

Pricing of a September cut was trimmed from 83% to 62%, with a similar move occurring in year-end rate expectations, where a second cut is 67% priced, down from over 90% earlier today. This has left yields around 6bps below intraday lows, with the dollar retracing more than 0.4%.

Fed projections turn hawkish, even as their view on the economy is little changed

While the upgrade to the 2024 dot is likely the main takeaway from the SEPs, that was not the only surprise. Despite broad expectations that any hikes taken out of 2024 would be pushed into 2025, the updated projections suggested a mere delay to the Fed’s easing cycle as opposed to a direct substitution of cuts from this year to next. As Powell highlighted, this essentially leaves the policy rate projection at the same end point in 2026. While this may be the case, long-run estimates have clearly risen to 2.75%, up from 2.56% previously. Moreover, the distribution of rate projections around the median forecast also skewed in a hawkish direction. The mean dot rose from 4.81% to 5.07% in 2024, from 3.78% to 4.16% in 2025, from 3.07% to 3.30% in 2026, and from 2.81% to 2.91% in the longer run. This more hawkish rate path does not come from better-than-expected growth either, with GDP projections unchanged in all years. Instead, this was seemingly motivated by policymakers expecting higher PCE inflation in the upcoming 18 months, which Powell largely attributed to base effects, at least to explain the uprating to this year’s projection. Both headline and core PCE are now projected to be 0.2pp higher in 2024, and 0.1pp higher in 2025 when compared to the March. This left headline PCE at 2.6% in 2024, 2.3% in 2025 and unchanged at 2.0% in 2026, while core PCE is now projected to run at 2.8%, 2.3% and 2.0% over the same period.

Set against an unemployment rate for 2024 that was unmoved at 4.0%, while the projections for 2025, 2026 and the longer run all rose by 0.1pp to 4.2%, 4.1% and 4.2% respectively, this suggests Fed members expect greater inflation persistence on the horizon, requiring the policy rate to remain at current levels for longer.

Not only did the Fed surprise with an upward revision to their 2024 dot to leave just one rate cut projected, but the moves for future years were also in a hawkish direction 

Fed’s caution highlights limitations to the dollar’s decline 

In response to today’s data, the dollar DXY index undershot its implied reaction to a 0.1 percentage point decline in core inflation, with the index only falling close to a percent. While turbulent cross-asset conditions are certainly playing a role in limiting the dollar’s decline, so too is the increased level of data uncertainty as today’s significant undershoot in core CPI dovetails uncomfortably with a surprisingly strong payrolls report late last week. This muddies the readthrough to the Fed’s reaction function, as evidenced by the hawkish shift in the Fed’s dot plot projections even once adjusting for the latest inflation data. This, along with the fact that it is merely one constructive inflation report and a lot of the disinflation pressures stemmed from highly volatile services components in May, should leave markets cautious in turning structurally bearish on the dollar, especially as previous episodes came to no avail.

As a result, we believe the dollar DXY index will continue to trade in recent ranges over the coming weeks, although this won’t be shared across all major currency pairs given the abundance of idiosyncratic risk currently at play.

Making a lot of noise with no direction: the dollar oscillates in a 1.4% range on significant data surprises



Simon Harvey, Head of FX Analysis
Nick Rees, FX Market Analyst


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