FOMC preview: what will the dots show?

With the Federal Open Market Committee unlikely to change the fed funds rate target at this week's meeting, the markets will concentrate on the Summary of Economic Projections and whether it shows expectations reduced to one or two 25 basis point rate cuts this year from the three suggested by the previous dot plot.

"Three things we'll be watching most closely in Wednesday's FOMC releases are any evolution of the forward guidance, any revision to the inflation forecast, and any change in the dot plot," said FHN Financial Chief Economist Chris Low.

Currently, forward guidance "is expressed as an explanation for why the Fed is not prepared to cut rates until certain conditions are met," he said. A change to "what will satisfy the Fed to ease" remains unlikely "as inflation has been higher than consistent with progress toward 2% through the first third of the year."

Additionally, the economy and labor market look strong, Low noted. Still, he expects the Fed to increase its inflation expectation, "and, as a result, the dots should be higher, too. We expect the median FOMC forecast will go to two cuts this year, though some participants are likely to advocate one or even none."

Of course, the May consumer price index being released on Wednesday, the second day of the two-day meeting, "complicates" the meeting.

Noting that if the meeting ends with no change to the 5.25% to 5.50% fed funds target rate it would be the seventh consecutive without a change, Michael Gregory, deputy chief economist at BMO Economics, said, "among the statement, projection materials and press conference, we reckon a common message will be to expect more of the same in the months ahead."

While April's inflation numbers were cooler than March's, he said, "More improvement is required to confirm the recent acceleration was more anomaly than trend and steer the three-month changes back to where they were before the pickup (which, for the underlying personal consumption expenditures price indices, was already the stuff of Fed rate cuts)."

The dot plot, Gregory added, "should show less appetite for rate cuts, particularly for this year, compared to the previous report." He expects the plot will suggest two rate cuts this year. "As for 2025 and 2026, March's median calls were also tenuous, with 75 bps (or less) of cumulative rate cuts supported by 10 (of 19) participants. As such, the degrees of easing and/or ending levels will likely change, if only to account for the higher starting point. Finally, for the longer-run level, March's median projection fell in between 2.50% and 2.625%, having been bumped up from 2.50%, and a further bump could occur."

Gross domestic product projections will be lower and unemployment rates higher, Gregory said. "The 2024Q4 projections for total and core PCE inflation (y/y) should also be revised up from 2.4% and 2.6%, respectively (they were both 2.8% in April). The latter suggests policy rates could remain higher next year too."

Fed Chair Jerome Powell will "emphasize" despite better labor market balance, "inflation is still too fast for comfort," reiterate that policy remain restrictive enough "to rein inflation in further, and more rate hikes are 'unlikely.'"

Expect talk of "slowing growth and the falling risk of high inflation," said Jeff Klingelhofer, co-head of investments at Thornburg Investment Management.

"As a result, I think the Fed will sound more dovish; this is a mistake," he said. "Today, the economic tug-of-war struggles between a relatively strong consumer and higher than comfortable inflation. While indicators show signs the battle is coming to a conclusion, it's not clear which side will be victorious."

Klingelhofer is hoping for a reaffirmation by the chair "that rates are in restrictive territory" and for Powell to "emphasize patience."

Morgan Stanley expects the statement will suggest progress on inflation "slowed rather than stalled," while the dot plot will project two rate cuts this year, although Morgan Stanley still expects three cuts, beginning in September.

Powell, they said, will push for patience, waiting for "more convincing data" that will allow it to lower rates.

"Our rates strategists do not expect markets to get much excitement from the dot-plot but see an asymmetric risk toward lower yields emanating from the FOMC press conference, as well as the CPI print that precedes it," Morgan Stanley said.

Analysts are still split on future policy.

"Strong growth, a tight labor market and sticky inflation argue for the Fed to stay on hold for the remainder of this year," said Subadra Rajappa, Societe Generale head of U.S. rates strategy.

The first cut will be in December, according to Yelena Shulyatyeva, senior U.S. economist at BNP Paribas. "The May employment report is consistent with continued rebalancing in the U.S. labor market, not deterioration."

Not much will change at this meeting, said Solita Marcelli, chief investment officer for the Americas at UBS Global Wealth Management. "Rate cuts are delayed relative to previous expectations, but further hikes are unlikely. We believe the Fed will ease interest rates twice this year, starting in September."

Wells Fargo Investment Institute Senior Global Market Strategist Scott Wren agreed. "Rate cuts on hold for now although clearly few expected cuts in the very near term. We have two cuts penciled in for 2024."

"We expect only minor changes in rhetoric and economic projections in the upcoming meeting," said Christian Scherrmann, U.S. economist at DWS. Data show less likelihood of "reflation, and thus potential rate hikes."

Scherrmann sees "a slightly more gradual path on rates than previously, moving from three cuts to two cuts in 2024 — thus aligning more closely with current market pricing."

DWS expects a "rate cut in Q3, and we remain slightly more dovish thereafter than current market expectations."

"We still see a lot of inflation pressure," said Payden & Rygel Chief Economist Jeffrey Cleveland. "I'm not as excited about inflation cooling off as some of my colleagues and maybe competitors are."

As a result, "the Fed is at best on hold for the foreseeable future," he said. "We see decent growth; we see sticky inflation but not an acceleration. But we don't see a recession."

Cleveland would not call it a Goldilocks scenario yet, which would require "month-to-month readings on inflation to cool off a bit more than we've seen."

While "not terrible," he said, it's not enough "to start to turn on the green light for the rate cuts."

According to Cleveland, "there's a high possibility that we go throughout this entire year without any cuts, and I think that's going to keep the front end elevated. Further out the curve when you think about the 10-year Treasury, I think it's in the range right now of being fairly valued.

"I don't think bonds are that cheap actually because of my view on inflation and because of my view of what the path of the Fed funds rate will be," he said.

Brian Rose, senior U.S. economist at UBS Global Wealth Management, said, "From the Fed's perspective, the upward trend in the unemployment rate and downward trend in job openings is a warning signal that they have kept rates too high for too long, and that recession risks are building."

If inflation were lower, rate cuts "would be a relatively straightforward decision," he said. "However, having previously been wrong on their inflation forecasts, the Fed's credibility as an inflation-targeting central bank is on the line. This makes it much more difficult to cut rates without stronger evidence that inflation is on track to hit its 2% target within a reasonable timeframe."

"A soft landing is in jeopardy," University of Central Florida Economist Sean Snaith said. "And it looks like the Fed may have eased up on the brake too soon."

While another hike appears to be off the table, he said, the Fed may have to cut "rates significantly later."

Expect "significant changes in the SEP," said Matthew Weller, global head of research at StoneX. "I expect the FOMC to revise up its forecast for GDP growth this year from 2.1% to 2.5%-plus, but the bigger question will be around the interest rate forecasts — the infamous dot plot — where we're likely to see a big hawkish shift to perhaps as few as one interest rate cut projected this year."