Fed meeting preview: 50bp hike expected, but will the impending CPI release shift the dial?

The FOMC head into their final rate decision of a historic year, with the central bank widely expected to raise rates for the seventh consecutive meeting. Those meetings have already seen rates soar to 4% from the January figure of 0.25%. This time around, markets are widely expecting to see another 0.5% increase, with the bank slowing their rate of tightening after 375 basis points worth of hikes. However, while it seems like we are set to see a slowdown in the pace of tightening, recent comments from Jerome Powell signal the potential for a higher than expected ‘terminal rate’. The two-day FOMC meeting concludes on Wednesday 14 December 2022.

Inflation data provides backdrop to decision

Inflation remains the dominant concern for the Federal Reserve, with the latest CPI figure due to be released as the FOMC commence their two-day meeting on Tuesday. Coming off the back of a period that has seen headline CPI fall from 9.1% to 7.7%, traders will be watching to see if that downward trajectory can continue in November. With energy prices largely being kept under control, Janet Yellen has speculated that we should see price growth continue to decline in 2023. Should that occur, there will be hope for the bulls as we move back towards target. The chart below highlights how energy has largely been responsible for the pullback in prices. However, with shelter responsible for around 30% of the CPI figure, we will want to see some of the core elements head lower to strengthen the case for disinflation.

Inflation data will have a tangible impact on the dollar, with the recent declines in CPI inflation leading to dollar declines. Should we see inflation continue to head South, it is likely that we will see the dollar also come under pressure. As things stand, inflation is tracking market forecasts closely, but traders will need to keep a close eye on energy prices as another spike could quite easily see those forecasts adjusted upwards.

Dot plot signals 2024 rate cuts

The September dot plot helped highlight two key elements that traders need to follow as we move forward. Firstly, the fact that we are expecting to see interest rate hikes slow does only show half the story for near-term Fed decision-making. The other element comes in the form of the ‘terminal rate’, with the decision over where interest rates stop rising likely to prove key to near-term sentiment. The dot plot highlights how the September outlook saw rates topping out around 4.25-4.5%. With markets now pricing in a 51% chance that rates hit 5-5.25% by May 2023, the adjustment to this dot plot ‘terminal rate’ will be an important element of Wednesday’s announcement. Secondly, there are many who believe that we could be in for a major market rebound once inflation drops and central banks start to ease monetary policy once again. The September dot plot served to highlight the wide range of projections for 2024. As inflation falls, the bulls will hope that these forecasts will point towards more rapid or swift rate cuts.

Growth and inflation forecasts key

The Federal Reserve meeting also sees the release of the latest economic projections, with markets obviously sensitive to the outlook for both growth and inflation. September saw 2022, 2023, and 2024 core PCE inflation projections lifted, while 2025 was speculated to bring inflation back down within touching distance of the 2% target. Given the declines we have seen for inflation since September, any adjustments from the Fed will be followed closely as a gauge of whether this move will continue. Meanwhile, the 2022, 2023 and 2024 growth outlook was downgraded across the board in September, with the impact of higher inflation and rates clearly expected to keep a lid on economic activity. Any movement on growth forecasts should be noted, but inflation will undoubtedly be key given the constant reminders that GDP will struggle in 2023.

What to expect from the FOMC

The bank are expected to raise rates by 50-basis points on Wednesday, with Eikon pricing in a 93% chance of such a move. Meanwhile, they attribute a 9% chance of a fifth consecutive 75-basis point raise. Beyond this month’s decision, markets will be closely following any commentary that brings greater clarity over where interest rates are frozen. Between commentary and the dot plot, any adjustment to the terminal rate should be reflected by markets.

Dollar index technical analysis

The dollar index has been heading lower over the course of the fourth-quarter thus far, with the late-September peak sparking a period of downside that remains in play. Whether that continues will come down to a number of factors. Should inflation decline further, that would likely help exacerbate the sell-off. Meanwhile, any larger than expected hike or significant upward shift to the terminal rate could help strengthen the dollar. The daily chart highlights how this bearish trend does still remain in play until price breaches the 106.87 swing-high.