FOMC Preview – It’s the data, not the sentiment

Tonight the Fed will keep rates on hold. In the press conference, Powell will likely repeat the messaging of last time: they will consider the totality of the Trump administration’s policies on tariffs, immigration, fiscal policy, and regulation in making their decisions, the only response to this level of uncertainty is to wait and see, and the Fed is well-positioned to react in a timely manner. In the May press conference, Powell noted that soft data was not enough to sway the Fed into making a move, they needed hard data. We think the same applies to Fed communication. This meeting is accompanied by a new round of projections which will be more informative about the Fed trajectory than what Powell will be willing to say during the press conference in the current political climate.

Over the first months of this year, inflation has surprised to the downside, while the labour market has remained healthy. Non-farm payrolls undershot high expectations in the early months of the year, while marginally exceeding lower survey estimates in recent months. The unemployment rate has kept steady at 4.2%, but non-rounded figures do show a gradual increase. Recent data therefore suggests that the Fed could move to the more dovish side, yet we expect the opposite.

The previous dot plot and projections stem from a pre-liberation day era. Moreover, only some of the committee members had incorporated implemented or expected tariffs in March. Liberation day surprised with more extreme tariffs, and even after the reversal day, a universal 10% tariff exceeds most of the March expectations. So even though data since then may have surprised somewhat to the dovish side, policy developments outweigh these surprises by quite some margin. The projections will therefore show significantly higher inflation forecasts, higher unemployment, and lower growth compared to the March forecasts.

These updates to the projections pull in both directions of the mandate, but we expect a hawkish shift in the dot plot. Recent Fed speak suggests some members might look through the tariff-induced inflation surge, while others may even think of responding to it. Indeed, short-term household inflation expectations have received quite some attention in speeches over the past weeks. Tariffs have significantly raised these short-term expectations, and the new oil shock from the Israel-Iran war may provide a further impetus. The FOMC members will therefore be mindful of both higher projected baseline inflation, accompanied by further upside risk, while downside risk to the labour market remains contained. As a result, we expect the dot plot to show a median of a single 25bps cut by year end, with some members even stating no cuts this year. This would represent a continued gradual move towards our base case of the Fed not easing at all this year, through a combination of higher inflation, risk of inflation expectations de-anchoring, and a labour market downturn that is muted by a decrease in labour supply.