Market expects a more hawkish Fed

By Elizaveta Belugina

The US consumer price index increased 0.4% in May, the biggest advance since February 2013, after climbing 0.3% in April. On the annual basis US inflation is 2.1% vs. 2.0% expected.

A pickup in inflation lessens the threat of a prolonged drop in prices that hurts economic growth, giving Fed officials reason to continue to scale back the QE program. For American consumers to cope with higher prices US economy needs continued jobs growth and faster wage gains (we’ll closely watch these indicators from now on to predict where the Fed is going).

The Fed officials will release their updated projections for interest rates, growth, inflation and unemployment after today's meeting. The regulator could lower the unemployment rate forecast (as this indicator has already fallen to 6.3% and the Fed expected 6.1-6.3% unemployment in Q4); increase inflation forecast (on the back of the higher recent data) and reduce GDP forecast (after weak Q1 GDP data).

As there’s an improvement in the labor market data and an increase in inflation, the market will be looking for hints about the future rate hikes. US dollar performance will depend on how Yellen comments these developments: the bias for USD is to the upside, but the scale of the move will be up to the Fed’s chief. On the one hand, Yellen wouldn’t want to cause a major move at the market like the one after Bernanke’s warning last year. On the other hand, she might need to clarify the Fed’s position and somehow mention this issue. The market is currently expecting a more hawkish Fed.

According to Jon Hilsenrath, a well-known expert on the Fed, “given recent improvements in the job market, the interest-rate outlook in the near term might tick ever so slightly up. In the long run, however, it is coming down at a glacial pace, a trend that looks likely to continue.”

The FOMC decision is due at 18:00 GMT. The central bank is largely expected to taper its asset purchase program by $10B to $35B. Yellen’s press conference will start at 18:30 GMT.



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