Will the Fed opt for a pause or a hawkish pause?

European markets closed higher for the second straight day as the latest US inflation data for May hit a two-year low and speculation about further Chinese stimulus boosted sentiment.

US markets followed suit, although enthusiasm and gains were tempered ahead of today's decision Fed, because there was caution before the announcement of interest rates.

Inflation is slowing down

After the US CPI inflation for May reached the lowest level of 4% in two years in the data published yesterday, the market expects that the US central bank will take a break today with a view to raising interest rates in July. Of course, this will depend on how the economic data plays out over the next 6-7 weeks, but even so, the idea that we would commit to a hike in July begs the question of why not hike now and keep options open for July, ensuring that financial conditions will not be loosened too much.

Today's May data about PPI this is likely to only reinforce the more dovish sentiment if, as expected, we see further evidence of a price slowdown with core prices falling below 3% for the first time in over 3 years. The headline PPI is expected to fall to 1,5% from 2,3%.

While Fed officials have portrayed a “skip-by” bias in their many briefings since the May decision to remove the line signaling that more rate hikes were imminent, there was always a risk that this kind of initial commitment could prove problematic.

So while markets fully expect the Fed to announce no changes today, Powell's biggest challenge will be to keep the prospect of a rate hike in July as a credible outcome while outlining the Fed's economic outlook for the rest of the year as well as 2024.

Fed forecasts may turn out to be crucial

The market consensus assumes that in 2024 the forecast for GDP will be 1,2%, and for 2025 it will be 1,9%. In turn, the unemployment rate is to amount to 4,5%, and at the end of 2023 to 4,2% (currently 3,7%). The inflation projection for 2024 may amount to 2,6%, and for 2025 to 2,1%. Core inflation, in turn, at the end of 2023 is to amount to 3,7%, and in the following years to 2,6% and 2,1%. In turn, the level of the federal funds rate may amount to 2023% at the end of 5,1 and further to 4,4 and 3,1%.

The decision on interest rates along with the communiqué and projections will be announced at 20:00 CET, and the press conference will start at 20:30 CET.