FOMC July 2017 Meeting Preview: Inflation expectations and balance sheet reduction

The Federal Reserve Bank will be holding its monetary policy meeting today. The central bank meeting is expected to see the fed funds rate remain unchanged at 1% – 1.25%. The probability of a rate hike is also extremely low, according to the CME Group’s rate hike probability tool.

Today’s FOMC meeting will not be followed by a press conference, making it extremely unlikely to expect any major changes today.

However, the Fed’s statement and forward guidance will be the main aspect that traders will focus on. After hiking interest rates three times this year, according to Fed officials, one more rate hike was projected for this year. Three more rate hikes are expected by 2018.

The Fed Chair Yellen had already indicated that the interest rates were near the neutral level, speaking to the US lawmakers a while back.

This meant that the Fed was comfortable with the current level of the interest rates, suggesting that there was no pressure to continue with the rate hikes; despite the fact that Fed officials projected another rate hike for the remainder of this year.

Fed’s view on inflation

Fed officials remain divided on inflation. Charles Evans, the president of the Chicago Fed, remarked just last week that lower inflation expectations would make it difficult for the Fed to achieve its inflation objective.

This potentially undermines the Fed’s intentions for hiking interest rates in the near term.

The concerns for subdued inflation were further accentuated by the recent congressional testimony given by the Fed Chair Janet Yellen. Ms. Yellen told lawmakers during her semi-annual testimony that “We’re watching this very closely and stand ready to adjust our policy if it appears that the inflation undershoot will be persistent.”

Lawmakers were also told that the central bank was very aware of the fact that inflation was continuing to run below the Fed’s target for years.

Some of the previous FOMC members also highlighted the risks. One ex-FOMC official was seen quoted as saying that the FOMC has opened itself to a problem.

With inflation briefly rising before staying muted, any comments on inflation from the FOMC statement will be closely watched.

Inflation expectations remain an important aspect when it comes to the Fed’s tightening cycle. Expectations from surveys conducted by the University of Michigan show that consumer prices could rise 2.5% on average in the coming years.

In the near term, this suggests that inflation could continue to run below the Fed’s 2% inflation target rate. Household inflation expectations also fell over the years with a majority of households expecting a drop in consumer prices. This potentially increases the risks of a further decline in expectations which could put the Fed at the cross roads.

However, businesses have taken a more optimistic view. According to a survey from the Atlanta Fed, businesses expect the Fed to remain tolerant of slower inflation. There were currently anchored around 2%, but still, there was a risk that inflation expectations from businesses could slip further.

Balance sheet normalization

The FOMC statement is also expected to show that the Fed will likely start its balance sheet normalization. Initially, the Fed outlined its intentions to unwind the balance sheet at a pace of $10 billion per month. This is expected to run for a while before the size would increase.

Officials have expressed their eagerness to begin with the balance sheet normalization as early as September. Therefore, any such clues from the central bank will likely be mentioned in the FOMC statement today.

While today’s FOMC meeting might not have the usual excitement, investors will be watching the event closely and anticipate the next move from the Federal Reserve.