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With a credible risk that the 2024 median dot would shift higher to imply just two rate cuts this year, markets breathed a sigh of collective relief as just one of the two required policymakers shifted their dot higher for this year, rendering the median projection unchanged.

Set against forecasts of higher growth, lower unemployment, and stronger core inflation, markets took this message as confirmation that the Fed remains confident that it will cut rates this year, likely at a quarterly pace commencing in June. However, the relief rally seems to be missing the point. While the 2024 dot was likely engineered so as to not spook markets that the Fed has lost confidence in its ultimate ability to ease, the Fed now sees one fewer cut in 2025, which isn’t offset in 2026.

Furthermore, policymakers now see greater risk rates remain higher for longer, as the distribution of projections for rates has shifted higher across the forecast horizon and the longer-term dot has gradually risen. This is because Fed members now see greater risks of more persistent inflation, evidenced through their core PCE projections.

While the median core PCE projection adjusted only slightly, with the 2024 forecast rising 0.2pp to 2.6% and 2025 and 2026 remaining unchanged at 2.2% and 2.0% respectively, the skew of forecasts once again shifted in a hawkish direction. Relative to December, one more FOMC member projects core PCE above 2.6% this year and 2.2% in 2025, while three more view risks of core inflation tracking above 2% in 2026 as skewed to the upside. In effect, this leaves the right hand tail risk for US rates alive, even as markets temporarily focus on Fed’s unwavering confidence to cut rates this year.

Thus, while today’s Fed meeting didn’t change much for markets, which were preparing for a shift in a more hawkish direction for the median 2024 dot, we still think the shift in the distribution of rates and inflation projections increases the risk of fewer rate cuts over the coming twelve months, should inflation confirm policymakers’ fears of greater persistence.

FOMC members continue to predict 3 rate cuts this year, but have revised up the 2025 and 2026 median by 25bps and lifted the longer-term projection moderately

Upside risks aren’t just evident in projections for the Fed funds rate, they have become more prominent in their inflation projections too, especially over the medium-term

For the dollar, while the Fed’s continued confidence in its ability to cut rates three times this year has resulted in a marginal decline this evening as defensive positioning for a more hawkish shift is shaken out, we think risks over the medium-term also remain tilted to the upside. With the Fed effectively confirming that risks of a higher terminal rate remain prominent in the US, and data and central bank meetings from Canada, the eurozone, Japan and Australia suggesting otherwise this week, we think rate differentials could still have a role to play in taking the dollar to fresh year-to-date highs over the coming six months, even as the Federal Reserve begins to cut.

Put another way, whilst other DM central banks may not have to front run the Fed as they seek to delay any easing until June at the earliest, it looks increasingly like they may need to outpace their US counterpart as the easing cycle progresses.

 

 

Authors: 

Simon Harvey, Head of FX Analysis

Nick Rees, FX Market Analyst

 

 

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