• The two-day FOMC meeting ends with an expected hawkish hold; Powell’s press conference comes with the usual dovish risks; Dot Plots should see a hawkish shift; the dollar tends to weaken on FOMC decision days; May CPI data take center stage
  
• French political uncertainty is weighing on French bonds and the euro due to heightened fiscal concerns; polls suggest the strong showing of France’s hard right NR party in the European Parliament elections could be replicated; ECB officials remain cautious; U.K. reported mixed real sector data for April
  
• Japan PPI inflation accelerated in May; China reported May CPI and PPI data; Thailand kept rates steady at 2.5%, as expected; Malaysia is concerned about the weak ringgit

The dollar is trading sideways ahead of the FOMC decision and CPI data. DXY is trading flat near 105.185 after three straight up days, and today’s developments will determine whether the rally can continue. The euro is trading higher near $1.0755 despite rising political and fiscal risks from France (see below), while sterling is trading higher near $1.2760 despite mixed real sector data (see below). USD/JPY is edging higher to trade near 157.35 and clean break above 157 sets up a test of the April 29 high near 160.15. MXN continues to underperform on ongoing political uncertainty. Data last week support our view that the backdrop of persistent inflation and robust growth in the U.S. remains largely in place. CPI data today should be consistent with this story and so the Fed is widely expected to deliver a hawkish hold today (see below). Recent developments underscore the widening economic and monetary policy divergences that support the U.S. dollar.

AMERICAS

The two-day FOMC meeting ends with an expected hawkish hold. At the May 1 decision, the Fed acknowledged the worsening inflation outlook by noting that “In recent months, there has been a lack of further progress toward the Committee's 2% inflation objective.” The Fed reiterated that it “does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2%.” With most inflation measures still running higher than desired since that meeting, we do not expect the Fed to shift its tone today.

Of course, Chair Powell’s press conference comes with the usual dovish risks. After the balanced Fed statement in May, recall that Powell came out full dove and said, “I think it’s unlikely that the next policy rate move will be a hike.” He then went on to say that rate cut timing will depend on the data, adding that unexpected weakening in the labor market could warrant a cut. It was painfully clear from that press conference that Powell was still itching to cut rates, and most likely remains so. Once again, it will all come down to the data, and right now, the data say no.

The Dot Plots should see a hawkish shift. It would take only one Fed policymaker to move from three cuts to two to raise the 2024 median by a similar magnitude from 4.625% to 4.875%. That’s a done deal but getting an even bigger move will be a bit more difficult. By our calculations, it would take an additional five policymakers to shift from two cuts to one to raise the median 2024 Dot to 5.0%. Looking ahead, the median Dot for 2025 currently stands at 3.875%. This implies three cuts next year, which seems reasonable, but the 2025 median would have to shift higher along with 2024’s.

Looking even further ahead, we look for a rise in the median longer-term Fed Funds rate. This is the Fed’s proxy for r* and the median shifted up in March to 2.563% vs. 2.5% in December. We know the debate about r* continues to rage, not just here but in many other countries. Indeed, both BOC and RBNZ recently raised estimates of their r*. For the Fed’s longer-term rate, it would take only two Fed policymakers to move to 2.75% to get the same shift in the median to 2.75% and that’s what we expect.

Updated macro forecasts will also be released. Growth and unemployment forecasts may be adjusted modestly to reflect recent softness in the data, while PCE and core PCE forecasts will likely be nudged higher for 2024 to reflect stickier than expected inflation.

The dollar tends to weaken on FOMC decision days. It has done so four straight times, starting with the December meeting. The September and November 2023 FOMC meetings resulted in rare dollar gains. Before those two meetings, the dollar had weakened seven straight meetings and 11 of the past 12.

Ahead of the decision, May CPI data take center stage. Headline is expected to remain steady at 3.4% y/y, while core is expected to fall a tick to 3.5% y/y. Super core accelerated to 4.9% y/y in April, the highest since April 2023. Of note, the Cleveland Fed’s inflation Nowcast model sees headline at 3.36% y/y and core at 3.55% y/y. Looking ahead to June, the model sees headline at 3.24% y/y and core at 3.66% y/y. PPI will be reported tomorrow.

EUROPE/MIDDLE EAST/AFRICA

French political uncertainty is weighing on French bonds and the euro due to heightened fiscal concerns. France’s public deficit widened to -5.5% of GDP in 2023, more than the government's -4.9% of GDP target and significantly more than the European Commission’s -3% of GDP threshold. Budget deficits in excess of -3% of GDP tend to lead the EC to trigger excessive deficit procedure against member states. President Emmanuel Macron’s government was already struggling to pass budget-cutting legislation through the National Assembly as he lacks the necessary majority. By calling snap legislative elections on June 30 with a second round on July 7, Macron is hoping to get a mandate from the French people to deliver spending cuts and reign-in the budget deficit. As he put it “I have confidence in the French people to make the right choice now to enable the country to face the great challenges ahead of it.”

Polls suggest the strong showing of France’s hard right National Rally (NR) party in the European Parliament elections could be replicated in the French National Assembly. The Ifop-Fiducial poll taken this Monday and Tuesday shows the NR would win the first round with 35% of the vote vs. 25% for a four-party left-wing coalition and 18% for Macron’s coalition. If so, parliament would be even more divided and getting the fiscal house in order would be extra complicated. The poor fiscal outlook prompt French Finance Minister Bruno Le Maire to warn “a debt crisis is possible in France, a Liz Truss scenario is possible”.

ECB officials remain cautious. Schnabel said the “last mile” of disinflation is proving to be bumpy. Patsalides said “Further actions of ECB will depend on the data we will have. We will see data at our next meeting and decide accordingly.” With regards to further cuts, Kazaks said “It’s dependent on how inflation behaves - inflation can sometimes come back. You have to be convinced that inflation remains at a low level.” Guindos and Nagel speak later today. Due in part to the cautious tone, the market now sees around 60% odds of a 25 bp cut September 12 vs. 75% at the start of this week. In our view, the ECB has room to deliver a cut then as eurozone inflation is in a firm downtrend and the recovery in economic activity remains subdued. With the Fed likely to deliver a hawkish hold today, the monetary policy divergences will continue to widen.

U.K. reported mixed real sector data for April. GDP came in flat m/m vs. -0.1% expected and 0.4% m/m in March. The details were mixed, as IP came in at -0.9% m/m vs. -0.1% expected and 0.2% in March, services came in at 0.2% m/m vs. -0.1% expected and 0.5% in March, and construction came in at -1.4% m/m vs. flat expected -0.4% in March. In y/y terms, GDP growth slowed a tick to 0.6%, with service sector strength preventing a sharper slowdown. In our view, the market is underpricing the odds of a policy rate cut in August (at around 40%) which is a headwind for GBP. A cut is more than fully priced-in for November.

ASIA

Japan PPI inflation accelerated in May. It came at 2.4% y/y vs. 2.0% expected and a revised 1.1% (was 0.9%) in April and is the highest since August 2023. This poses an upside risk to inflation if businesses manage to pass on the input cost increases to consumers. Japan’s May CPI print will be released next week.

China reported May CPI and PPI data. CPI came in a tick lower than expected at 0.3% y/y and was steady from April, while PPI came in a tick higher than expected at -1.4% y/y vs. -2.5% in April. This was the smallest drop in PPI since February 2023, but the economy is still struggling to escape deflationary risks. Monetary policy is likely to remain loose or get even looser and so the monetary policy divergences point to a weaker yuan.

Bank of Thailand kept rates steady at 2.5%, as expected. Only a couple of analysts polled by Bloomberg looked for a 25 bp cut. It was a less dovish hold compared to previous meetings, as only one MPC member dissented in favor of a 25 bp cut vs. two members at the last two meetings in April and February. furthermore, the statement scrapped the phrase that “uncertainties on the Thai economy remain high.” BOT kept its growth and inflation forecasts largely unchanged. The swaps market is pricing in steady rates over the next three months followed by around 50% odds of a 25 bp over the subsequent nine months.

Bank Negara Malaysia is concerned about the weak ringgit. Deputy Governor Adnan Zaylani Mohamad Zahid said, “We are still looking at what are the various other measures which we can undertake, initiatives that we can undertake to ensure that the ringgit remains stable and supported.” He added that it’s important for the ringgit to “perform like we expect it to perform to reflect the strength of our fundamentals.” Real interest rates are modestly positive but it’s clear that Bank Negara does not want to hike rates to support the ringgit at this point.