With Fed likely to stand pat on rates, all eyes are on its ‘dot plot’ for fresh clues on outlook

THE biggest news surrounding the US economy this week will likely not be the Federal Reserve’s policy statement, but rather the consumer price inflation data that precedes it or the press conference that follows it.

It’s almost certain that the US central bank will leave interest rates unchanged for the seventh successive meeting, which concludes on Wednesday (Jun 12), at the multi-year high of 5.25 to 5.5 per cent. It’s also unlikely that the Fed will change much of the language in its statement.

The unpredictable part of the six-weekly ritual this time, however, is likely to be the “dot plot”, where central bankers pencil in their expectations for rate changes in the coming year.

“The focal point will be the summary of economic projections,” said J D Joyce, president of Texas-based financial advisory Joyce Wealth Management. “The Fed has been pretty consistent in its projection of three cuts this year.”

With the recent uptick in both consumer price and producer price indices, tallies of retail and wholesale inflation, and surprisingly strong jobs data, these projections are almost certain to change, said observers.

Some Fed officials have even talked about putting rate increases back on the table, just to make sure the central bank has not prematurely declared victory over inflation – as happened back in the 1970s, in what was widely considered to be the biggest policy error in the Fed’s history.

The “dot plot” for the rest of the year is now as unpredictable as it’s ever been, according to some Wall Street strategists.

“Whether it’s zero cuts, or one, or two or three – any of those is a possibility,” said Joyce. “It’s a little far-fetched to see zero, but it’s probably a little far-fetched to see three as well. Maybe it will be two cuts.”

The Fed’s predictions are sometimes taken with a pinch of salt by participants in the stock and bond markets. The Fed’s funds futures market is often relied upon as a more accurate indicator of the US central bank’s plans than the words of the central bankers themselves.

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For the Fed’s funds futures market, this week’s statement from the Fed and the subsequent press conference with chairman Jerome Powell could well be an afterthought. The latest reading of consumer price inflation, which is due to be released on Wednesday morning (US time) will be the critical variable for this market.

Economists at brokerage Bank of America Global Research have forecast a month-on-month inflation increase of 0.3 per cent.

“A print in line with our expectations should support market pricing for cuts starting in December,” they predicted. “A 0.2 per cent print could see expectations for cuts pulled forward to September, and a 0.4 per cent print would decrease likelihood for cuts this year.”

An “upside surprise” seems the more likely outcome. That’s based on the stubbornly strong US economy, epitomised by last Friday’s jobs report for May. Not only did the US add 272,000 workers to payrolls, roughly double what economists had predicted, wage growth also picked up.

The International Longshoremen’s Association, which represents all the dockworkers on East Coast and Gulf Coast ports, was the latest union to threaten a strike this week, citing the threat of automation.

Labour disputes, and efforts to forestall them, have risen, even as artificial intelligence and other productivity improvements have lifted corporate profits. The upward pressure on wages is likely to continue if the economy keeps running hot.

“The labour market is cooling, but it’s not cool,” said Bank of America economists. 

The world’s largest economy could even be heating up, which analysts said would be a good sign for corporate profits but a bad one for inflation.

Real gross domestic product – defined as nominal GDP adjusted for inflation using a price index – has been particularly volatile of late, said Joyce. After dipping as low as 1.8 per cent in May, the estimate for second-quarter growth is now above 3 per cent.

There is, however, one other critical variable for traders this week, and that is Powell himself.

Previous Fed chiefs, including Ben Bernanke and especially Janet Yellen, had a gift for staying on message, said Lorenzo Di Mattia, the manager of hedge fund Sibilla Global Fund.

When Yellen spoke about policy plans, she usually recapitulated phrases that were already enshrined in the formal statements. She may not have cleared up all the ambiguity in the statement, but she never added any further confusion.

Powell has earned a reputation on Wall Street for shooting from the hip during his press conferences, stunning markets with tacit promises to cut rates or sudden swings to hawkish rhetoric. He has dropped such bombshells at several press conferences in the past year since hopes of a policy “pivot” first emerged.

If Powell does somehow go ahead and announce rate cuts, what’s just as important will be the reasons for doing so, and not just when the cuts will take effect.