/A summer of quiet contemplation For Professional Investors Only

A summer of quiet contemplation For Professional Investors Only

The US Federal Reserve is unlikely to raise rates at its Federal Open Market Committee (FOMC) meeting on Tuesday. However, it will be interesting to see the FOMC’s view on why inflation figures in the US remain soft. The FOMC may also use the session to provide more details about the pace and timing of proposed balance sheet tapering.

The Fed has a dual mandate to ensure full employment and a medium term inflation rate of 2%. Yet there is a growing divergence between consistently disappointing inflation figures and a US labour market which is almost at capacity. Indeed, the Fed’s preferred gauge for inflation – the Deflator of Personal Consumption Expenditure (PCE index) – has actually dipped in recent months to 1.4%.

Market participants will be particularly keen to hear the FOMC explain this dichotomy at its statement on Tuesday. Chair Yellen recently commented that the disparity was due to “transitory factors” and we expect that the dollar’s strength, as well as declining oil prices, will be mentioned in this context. Consequently, investors will focus their attention on whether there is any change in the Fed’s medium term view of inflation, and its subsequent impact on rates.

Here though, we expect no changes. The Fed’s “dot plots” indicate four more hikes until the end of 2018 and we expect this plan to be reiterated. Nevertheless, there is still a gap between these communications and market anticipations. Currently, market participants seem totally agnostic, with only a little more than one hike priced in for the next 18 months. This means it will be down to the FOMC to highlight the Fed’s conviction in the dot plots as a course of action, despite countervailing weak inflation.

At its last meeting the Fed also announced its plans to start tapering the balance sheet. Other than “this year”, the exact schedule and details were held back. Tuesday’s FOMC meeting could be a good opportunity to publicise how the process of balance sheet tapering will take place.

Overall the meeting is unlikely to be a strong market mover. After the ECB’s dovish stance last week, central banks appear to be settling down for a quiet summer.


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