FOMC preview: will rising inflation bring a more hawkish Fed?

The Federal Open Market Committee (FOMC) return to the fold this week, with investors keenly looking out for clues from a meeting that is likely to be more talk than action. While the meeting commences on Tuesday, it comes to a head on Wednesday 16 June.

Inflation unlikely to derail stimulus for now

Wednesday’s meeting has been billed as the main event of the week, but we look unlikely to really see anything particularly tangible when it comes to the policy mix.

​That comes despite the sharp rise in inflation seen over recent months, with headline inflation jumping to 5% in May. However, it was the core reading which particularly caught the eye, with the 3.2% figure representing the highest level since 1992.

The interest rates will likely move last when the Federal Reserve (Fed) finally choose to tighten the dials, with the committee expected to trim the asset purchase programme first.

Nonetheless, the Fed typically telegraphs their intentions prior to any adjustment, highlighting how the market expectations of no movement on rates or quantitative easing (QE) will likely be the case.

​With that in mind, markets are pricing in a 95.7% chance that the Fed will keep rates steady.

Economic recovery proves uneven

While rising inflation may signal to many that the Fed should start thinking about a less accommodative stance, recent volatility in the jobs data has highlighted that more needs to be done.

Despite improvements, the headline unemployment rate of 5.8% remains well above the 3.6% seen prior to the pandemic. Meanwhile, the ongoing impact of the Covid-19 outbreak remains evident when looking at the participation rate.

​From a historical perspective, the current level of 61.6% represents levels not seen since 1977.

That lack of participation also helps to prop up the unemployment rate, which would be markedly higher should those out of the jobs market choose to be counted.

With that in mind, it is worthwhile looking at the U6 rate (rather than the traditionally referenced U3), which is a wider gauge of unemployment.

​This shows a rate of 10.2% unemployment, which compared to the 6.9% level seen at the beginning of 2020.

Language could be key

With doubts over whether we will see the Fed act on either rates or asset purchases, many will be looking at whether the Fed chair Jerome Powell will shift tone towards a less dovish stance.

Fed members have already started that tapering talk will increase over the coming months. With that in mind, keep an eye out for any change in tone towards a more hawkish stance that is increasingly open to the notion of trimming asset purchases.

Powell has repeatedly laid out a highly dovish stance, insisting that this rise in inflation is expected to be transient in nature.

However, with prices having gained so much ground, markets will be keen to know where the Fed views that temporary rise in prices as having transitioned into something more worrying.

​A greater degree of clarification over just how the FOMC are judging inflation to be transitory rather than persistent could provide a good gauge of when the tide will turn on monetary policy.

Keep an eye out for the latest projections

This meeting provides markets with a fresh batch of economic projections. For obvious reasons, inflation will likely provide the key area of note given the Feds insistence that this rise in prices will be fleeting.

Nonetheless, it will be difficult to get past the rapid rise in inflation over recent months. With that in mind, keep an eye out for a likely upward revision to core inflation forecasts.

On the growth-front, it also looks likely that recent developments will spark an upward revision to the 2021 gross domestic product (GDP) prediction.

​Elsewhere, watch out for any shifts in the dot plot, with many looking out for a potential shift to pencil in a single rate hike in 2023.

Dollar index technical analysis

The dollar index has been on the rise of late, with falling treasury yields helping to prop up the haven asset. There is a good chance we could see this move higher persist if we see the price break through the 9063 resistance level.

​In particular, increased tapering talk could bring about another push higher for the greenback.