The week ahead: FOMC dot plot and France heads to the polls

Central bank watch will intensify this week, as we get the Fed and the Bank of Japan announcing their latest policy decisions. After the ECB’s hawkish cut last week, the focus in Europe will now turn to the outcome of the European elections, and the political shift to the right in the EU, along with a surprise snap French election. This has weighed on the euro and European stocks at the start of this week.

Dollar is king once more

As we start a new week, there has been a major shift in global interest rate expectations. The ‘hawkish cut’ from the ECB last week has reduced the number of further rate cuts from the ECB this year to one more cut, down from two further cuts. The market now expects Eurozone interest rates to end the year at 3.32%. The mega US non-farm payrolls report on Friday, which suggests that the US economy continues to generate job growth even though there was a slight uptick in the unemployment rate to 4%, has pushed out the prospect of a cut from the Federal Reserve to December. Global stock markets had a volatile week. The S&P 500, the Nasdaq and the Eurostoxx 50 indices managed to register gains for the week, while the FTSE 100 and other European indices posted losses. The dollar was the strongest currency in the G10 FX space as it was given a boost by the recalibrated Fed rate cut expectations.

FOMC: Dot plot in focus

The FOMC meeting on Wednesday looms large for financial markets this week. The key question that the market wants to know is whether interest rates are restrictive enough, especially with the much stronger than expected payrolls report for May and a recovery in the ISM service sector survey. The Fed will also release their latest economic projections, and also their latest Dot Plot at this week’s meeting. Both will be watched closely. The economic projections are likely to revise higher both the inflation forecast and the forecast for the unemployment rate. The unemployment rate hit 4% in May, the FOMC’s March median forecast for the unemployment rate was 4%, but that was for the whole of 2024, thus we could see some revision to this estimate later this week. Core PCE inflation for 2024 was revised higher to 2.6% in March from 2.4% in December, the core PCE deflator, the Fed’s preferred measure of inflation was 2.8% in May. Average hourly earnings for last month also rose to 4.1% from an upwardly revised 4% in April, which suggests that there is inflation in the US economic pipeline, which the Fed will also need to take account of.

Could US CPI surprise to the downside?

This week also sees the release of US CPI and PPI. The annual headline inflation rate is expected to remain steady at 3.4% last month, the monthly rate of headline CPI is expected to rise at a moderate 0.1%, perhaps taking into account the sharp fall in oil prices. The price of WTI crude has fallen by 3.64% in the past month, and gasoline prices are down more than 6%. There is a risk that analysts are underestimating these effects, and the headline CPI reading could be weaker than expected. If that happens, then it may throw into confusion the outcome of the FOMC meeting, which could weigh on the dollar and push forward expectations for Fed rate cuts.

Dot plot downgrade

As ever, core inflation is really worth watching, economists expect a small decline to 3.5% from 3.6% in the annual rate for May. The monthly rate is expected to have expanded by 0.3%. Producer price data is released after the FOMC meeting, this is expected to show an uptick in final demand prices, which are expected to have risen to 2.5% from 2.2%, the core PPI is expected to increase to 2.5% from 2.4%. This is likely a reflection of a strong US economy. The Atlanta Fed’s GDPNow projection for Q2 GDP was revised higher to 2.6% last week, up from a 1.8% reading a week ago. As mentioned above, the market may have to deal with weaker headline CPI and a more hawkish Fed this week. The market is currently expecting only one cut from the FOMC this year. However, all eyes will be on the Fed’s Dot Plot, which will also be released on Wednesday. In March, the Fed reaffirmed their base case of three rate cuts for this year, but this looks increasingly unlikely. The focus will now rest on whether the Fed reduces their Dot Plot to one or two cuts for this year. If the Dot Plot points to two cuts for this year, then this could be considered a dovish event. Bloomberg’s Fed Speak index is close to its highest level since December, as the Fed has shifted to a less dovish tone, however, this index has ticked lower in the past few weeks. Since the last Fed meeting, 2-year Treasury yields have ticked higher slightly and are up by 20 basis points to 4.88%. The market is looking for direction from the Fed at this meeting, however, a robust economy and strong levels of immigration propping up the US labour market, could mean that dovish rhetoric from the Fed remains elusive for now.

European politics moves to the right, as France heads to the polls

The outcome of the European elections have caused a ruction in European politics. Emmanuel Macron has dissolved parliament and will call for new parliamentary elections from June 20th.  Marine Le Pen’s French Rassemblement National Party looks to have come first with 33% of the vote, crushing President Emmanuel Macron’s centrist alliance, who only managed to secure 15% of the vote. The Rassemblement Party called on Macron to dissolve parliament in the aftermath of this election, which highlights how the Far Right are setting themselves up as the de facto governing party of France.

Germany and France swing to the right

France is not the only country to swing to the right in the EU elections. German Far right parties also performed well. Far right and hard right parties are expected to win 160 seats out of a total of more than 720 in the EU Parliament, with the centre right securing the most seats. This is significant, since the Far Right is expected to win more seats than socialist parties and the greens, who are expected to be the biggest losers. While last week’s shock election results in Mexico and India caused massive ructions in their domestic stock and FX markets, the impact on the euro and European stocks may be less acute. However, no one expected France to call parliamentary elections on the back of the EU elections, so the shock factor may weaken the euro and European stock markets at the start of the week.

The question for traders of the euro and European stock markets is just how radical will Marine Le Pen and Jordan Bardella be if they do well in the French parliamentary elections? Their watchword is sovereignty, so what will this mean for relations with the EU and NATO? If the Rassemblement Party does well in the upcoming parliamentary elections, then it could take them a step closer to winning the Presidential elections in 2027. Combined with Georgia Meloni in Italy, the Far Right are making deep inroads into Europe’s top echelons of power.

Support for the German Chancellor has also slumped and Olaf Scholz’s party has suffered a humiliating defeat and are only expected to win 14% of the vote. There could be questions asked around his leadership, and we could some political turmoil in Germany on the back of the EU vote, although we don’t think Germany will hold a snap election like France.

ECB speakers to expand on hawkish cut

Outside of politics, it’s also worth watching the final May readings of CPI in France and Germany, along with industrial production, trade and investor confidence data for the currency bloc. There are a raft of ECB speakers this week. It will be interesting to see if any of them roll back on the idea of a hawkish cut, and the market’s rapid repricing of ECB rate cut expectations for this year.

UK labour market data may signal delay to rate cuts

In the UK, the unemployment data along with wage data will be worth watching closely. The unemployment rate is expected to remain steady at 4.3%, while wage growth is also expected to remain unchanged for April at 5.7%, and 6.1% excluding bonuses. Both rates of pay growth could be seen as too high to justify a rate cut from the Bank of England in August. The swaps market is currently pricing in a 44% chance of a rate cut from the BOE in November, and we do not expect this labour market data to shift the dial too much, unless we get a surprise reading, particularly for wage data.

Bank of Japan to guide on summer rate hikes

Lastly, the highlight in Japan will be the Bank of Japan meeting on Friday. Economists are not expecting any change to policy at this meeting, instead there is a 61% chance of a rate hike from the BOJ in July, and a 67% chance of another rate hike in October. The market will be looking for a clear signal from the BOJ that they will hike rates and normalize monetary policy further at this week’s meeting. So far, the new BOJ governor has been clear in his desire to hike rates, however, economists also expect the BOJ to announce a further slowdown in bond buying, which could put the brakes on a weak yen and limit the need for official intervention from the BOJ to prop up the currency. The yen is down by more than 10% YTD vs. the USD, and in the past month the yen has dropped more than 1% vs. the USD even though the Japanese authorities have been intervening to prop up the currency. Thus, the only long term and sustainable solution to stem yen weakness is through BOJ policy normalization. The BOJ has a tough job to do, it must stabilize yen weakness even though the economy contracted in Q1, and the inflation rate is trending lower. The outcome of this meeting could determine if a July rate hike is still in the cards.