There are a lot of expectations ahead of the conclusion of the FOMC meeting which concludes tomorrow. Not because there is much chance of a change in policy. But investors are going to be really keen to go through the statement with a fine-tooth comb for any clues about when the first rate hike will happen.
We all know that the Fed will “normalize” rates at some point. They agree that rates are too high, or “restrictive” to use their jargon. But when they believe inflation is convincingly heading towards the target is a matter of opinion. And the FOMC meeting provides a dose of insight into what FOMC members are thinking. And that could significantly drive the markets.
Bringing Expectations Back Into Line
A lot has changed over the last month or so. Just six weeks ago, the markets were betting substantially on a rate cut in March, which would be followed by five more over the course of the year. Since then, the market has drastically pared back those expectations. So much, as a matter of fact, they now align with what the Fed projected at the start of the year.
The thing that could really jolt the markets now that the forward rates are lining up with the Fed, is if the FOMC comes along and modifies its rate cut projections. The current forecast is for three rate cuts (or 75bps) of cuts by the end of the year. The market is still more dovish than the Fed, predicting the first cut in June. The forecast from the FOMC members is in the “second half” of the year, which would mean July at the earliest.
What to Look Out For
This time around, the Fed will release an update to its “dot-plot matrix”, which is a summary of where FOMC members think rates will be over the course of the next several quarters. The key will be what is expected from here to year-end. As mentioned, the current consensus is for three rate cuts.
But, given the pick up in inflation lately, and the strong (albeit somewhat mixed results in February) prints in the job markets, there is increasing speculation that the Fed could reduce the number of rate cuts it expects this year. Just as the market is finally coming around to agree with the Fed, it could turn more hawkish. This isn’t priced in, so it could give the dollar a substantial boost.
Why Hasn’t the Dollar Moved?
Despite the market essentially giving up on 75bps of easing over the last few weeks, there hasn’t been an equivalent move in the dollar. In fact, the greenback is still weaker than it was around mid-February, despite the surge of the last couple of days.
How come? Well, yields on the bonds have been fairly stable despite the change in forecasts on the Fed. That means that the attractiveness of the dollar hasn’t gone up as much. The reason for why the yields haven’t followed the futures market might have to do with the lower amount of debt that the Treasury is issuing. With fewer bonds going on the market, interest rates tend to be lower. Which in turn weakens the dollar. That phenomenon could put a cap on the potential upside to the dollar even if the Fed comes out as more hawkish than expected.
