FOMC preview: No Fed put, but watch out for inflation revisions

The Federal Reserve will announce their latest policy decision on Wednesday 19^th March. The market expects no change in interest rates at this meeting, instead the focus will be on the Federal Reserve’s updated economic projections and the Dot Plot, along with Jerome Powell’s press conference.

What a difference a few weeks make. At the last FOMC meeting at the end of January, hopes were high that the US economy would continue to grow at a strong pace at the same time as inflation moderated. However, the outlook for the US economy has changed dramatically in just a few weeks. The backdrop to this meeting includes a global trade war and a stock market rout. The S&P 500 has fallen by 7% since the last FOMC meeting, and the Nasdaq 100 is lower by more than 9%.

Tariffs and inflation

This is not Powell’s first rodeo when it comes to tariffs. He was at the helm during President Trump’s first term in the White House. However, there are two significant differences. Firstly, Trump’s latest tariffs are more broad-based in nature, and more wide-ranging, which adds an extra layer of complication to the assessment of tariffs on the global economic outlook. Secondly, the way the Fed views tariffs may have changed since 2018. Back then the Fed predicted that tariffs would cause deflation, as higher prices would be cancelled out by rising unemployment and a slowdown in growth. However, since then the Fed’s views have changed. They now see tariffs as having a persistent inflationary impact. All though final goods may experience a one-off price increase, the risk is that tariffs on intermediate goods – the components of final goods – mean a continuous upward impact on inflation in the US for as long as tariffs are in place.

The Fed’s latest inflation forecasts will be watched closely. The consensus seems to be that the Fed will revise down growth expectations and inflation and unemployment rate forecasts will be revised higher. The last forecasts that were released in December, saw PCE inflation for 2025 revised higher to 2.5% from 2.1% in September. Core PCE was also revised up to 2.5%. If inflation forecasts are revised higher, then it makes the Fed’s 2% target rate harder to achieve. If the Fed’s inflation forecasts have a 3% handle, this could be the catalyst for further volatility in financial markets.

The outlook for interest rates

Even if inflation forecasts are revised higher, we think that the Fed will keep their forecasts for interest rates steady.  There has been a dramatic change in US bond yields since the start of this year. For example, 10-year US Treasury yields have fallen by 25bps, and the 2-year yield is lower by 19bps. Back in December, the Fed’s median forecast for interest rates this year and next were 4.375% and 3.87%. The Fed Fund Futures market currently expects US interest rates to end 2025 at 3.73%. The market is slightly more dovish than the Fed at this stage, and we expect the Fed’s Dot Plot to converge towards market-based expectations for interest rates at this meeting. However, we think that the Fed will signal that more rate cuts are not possible in the current environment.

Will the Fed’s ‘hawkish’ views persist?

On balance, so far this year the Federal Reserve is leaning towards a hawkish stance, as members sound concerned about the outlook for inflation on the back of the global trade war. It will be worth watching FOMC member Christopher Waller in the coming weeks and months. Jerome Powell’s term as Fed chair will end in a year, and Waller is in the front line to replace Powell. He has shifted to a more dovish stance since President Trump’s inauguration. If he continues to be the main candidate to replace Powell, then his speeches and outlook could have a big impact on markets in the coming months.

The end of the Fed put?

When politics gets in the way of the economy then things can get messy, as we have seen with the large sell off in US stocks. The Fed is unlikely to step in to prop up US equities at this stage. So far, the declines in US stock indices look like a healthy correction, fueled by last year’s top performing stocks coming off the boil. Added to this, although small cap stocks in the US have fallen at a faster rate than blue chip stocks, this does not mean that economic disaster is around the corner.

Likewise, the decline in sentiment indicators in the US has not been matched by a decline in the real economic data. This may happen, but for now it is too early to tell the economic impact from President Trump’s tariffs. The largest wave of tariffs are not expected until April 2^nd, which means that it could take some months before Trump’s trade policies, show up in the  real economic data. If the actual data shows signs of a rapidly shrinking economy, or a surge in the unemployment rate then this is when the Fed could take action.

For now, the Fed is likely to remain in wait and see mode and commit to being data dependent for the foreseeable future.

The Dollar impact

The dollar index is consolidating at a low level, however, there is no clear sign that the greenback is attracting buying interest. EUR/USD is sticky around the $1.10 level, while GBP/USD has touched $1.30 in recent days, The Fed meeting could trigger more downside for the dollar, particularly if growth is revised down, while inflation is revised higher.

The stock market impact

The US stock market sell off reaccelerated on Tuesday, led by big tech. The S&P 500 is moving closer to correction territory and is down by more than 8% in the past month. All of the Magnificent 7 tech stocks have now eradicated any YTD gains, after Meta saw its gains disappear on Tuesday. However, the main US blue chip index is down less than 5% YTD, which is why the Fed Put is unlikely to be activated at this stage.

The fact that US stock markets have not been able to find a lasting bottom is a sign that we could experience another leg of this sell off, before US stocks attempt to stage a recovery. The catalyst for the next sell off could be tonight’s Fed meeting, especially if we see a large upward revision to inflation forecasts.