All eyes are on Wednesday’s FOMC meeting, in which it might be revealed that the Fed won’t hike any more this cycle. But, before then, the release of US inflation figures tomorrow can set up expectations even as the members of the rate-setting committee are deliberating what to do. Here’s what the markets are likely looking for from these two major events:

Setting up Expectations

Over 98% of traders expect that the Fed will hold rates steady when it meets for the last time this year. The main issue is whether or not Fed Chair Jerome Powell comes out to say that rates will be kept at this rate going forward and drop the threat of further rate increases. The likelihood of that comes down to what happens with the inflation rate tomorrow.

The consensus among economists is that the headline annual CPI rate will drop to 3.1% from 3.2% prior. But where the main focus will be is the core rate, since that’s the one that is closely tracked by the Fed for rate decision purposes. The core rate is expected to continue doubling the target at 4.0% annual, the same as last month. What that means is a beat of just one decimal would show that core inflation has increased. That could send alarm-bells through the markets, as the Fed will be very reluctant to ease up if inflation is growing.

The Fed and the Markets Still Don’t Agree

Even if inflation comes in line with expectations, there is still another problem. The markets see the Fed cutting by at least 125bps over the next year. That’s equivalent to five ‘standard’ quarter-point rate cuts, with the first expected as early as May. The Fed’s projections, on the other hand, see rates staying high through the rest of the year.

The Fed is expected to update its economic projections at the coming meeting, and that could include a revision to where rates are expected to be. If they align more with the market, then the dollar could end up weakening as traders feel vindicated about their projections. But, if the Fed provides an overly hawkish outlook, then the dollar could get a boost at the expense of risk assets.

Where to Find the Answers

There are two key documents that could rile up the markets even if the Fed announces no change in policy. The first is the so-called “dot-plot” matrix, which was last released in September. This is a summary of where FOMC members see rates over the next year or so. The last time it was released, it showed a rate hike was expected by year end. The market believes the dot-plot will show rate cuts next year. If not, it could be interpreted as hawkish.

The other document is the Summary of Economic Projections (SEP), where there is considerably more agreement between the market and the Fed. Both see employment and inflation coming down next year, but still not reaching targets That would affirm a trajectory of keeping rates higher through that period. But if the economic projections were downgraded, the market could take it as a sign of cuts happening sooner than the Fed says they will, and that could weaken the dollar.

However, in the past, the Fed has a habit of being more hawkish than the market has projected. Given so many bets that there will be a more dovish Fed, there seems to be a higher chance that an upside would be a bigger surprise than a miss of expectations.

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