FOMC Preview: The hiking cycle is still far away – Rabobank

While inflation is seen as an upside risk to the projected hiking cycle, COVID-19 and its mutations are a downside risk. Analysts at Rabobank point out there is no update of the dot plot this month, so officially the median FOMC participant will still expect two hikes of 25 bps each in 2023. They argue upside risks to inflation could lead to another upward shift in the dot plot, but the downside risks from a prolonged impact of COVID19 could still push the dot plot in the opposite direction.

Key Quotes: 

“The next meeting of the FOMC takes place on July 27-28. The Fed’s baseline scenario is that the recent rise in inflation is temporary. However, Powell’s testimony to Congress showed that the Fed has started to describe what it would take to shift to an alternative scenario.”

“The FOMC will continue its discussion on tapering started in June. There will be two announcements in the remainder of the year: the decision to start tapering and “advance notice” of this decision. Both are likely to have more market impact than the actual start of tapering. “

"The hiking cycle is still far away. The June projections showed that the median FOMC participant expects to hike twice (assuming rate hikes of 25 bps each) in 2023. The dot plot also shows that it would not take much to get to a first hike in 2022. However, this would then most likely be toward the end of 2022. The FOMC continues to see the high inflation figures of recent months as something temporary. As long as this is the case, the Fed will be in no hurry to hike. After all, the new flexible average inflation targeting (FAIT) strategy adopted last year allows for temporary overshoots of the 2.0% inflation target to make up for past undershoots.”

“There is no update of the dot plot this month, so officially the median FOMC participant will still expect two hikes of 25 bps each in 2023. However, the discussions on inflation and COVID-19 may indicate which way the Committee is leaning as we head into the September meeting which does involve an update of the projections. Upside risks to inflation could lead to another upward shift in the dot plot, but the downside risks from a prolonged impact of COVID19 could still push the dot plot in the opposite direction.”