The growing uncertainty regarding the direction of tariffs and oil prices, and their impact on inflation, is intensifying a risk regarding tonight's Federal Reserve decision, namely that Fed officials may not be able to cut interest rates twice this year as they previously expected...
The Federal Reserve is set to announce its June interest rate decision at 2 AM Beijing time on Thursday. It is not hard to foresee that the 'dot plot,' which reflects the Fed officials' expectations for changes in interest rate policy this year, will clearly become a focus for many market participants at that time.
In the previous dot plot from March, the median expectation of Fed officials showed two rate cuts before the end of this year. Meanwhile, federal funds futures traders currently believe that the probability of the Fed actually cutting rates less than twice is only 37.7%!
And this clearly brings a huge risk to the market tonight: if the June dot plot reflects that the expectation for rate cuts this year is reduced to only one, will investors who were 'eagerly anticipating' two rate cuts be greatly disappointed?
Matthew Ryan, head of market strategy at financial services firm Ebury, stated in an email on Monday that the firm believes that two rate cuts this year will still be the baseline expectation of most Fed policymakers, and given the significant uncertainty surrounding current tariffs, they may not have enough confidence to substantially change their views. However, there is also a risk that a minority of officials believe the number of rate cuts this year will be less than previously expected, which could be enough to tilt the decision-making scale toward just one rate cut (25 basis points) in 2025.
He added, "A hawkish dot plot, combined with Powell's emphasis on not rushing to cut rates, may provide some room for the dollar to strengthen later this week."
In the past three months, Fed officials have been expecting the inflation rate and core inflation rate (based on their preferred inflation gauge, the PCE price index) to reach 2.7% and 2.8%, respectively, by 2025, and then gradually decline to the 2% target level by 2027 and beyond.
Since last December, they have also 'held their position' in three consecutive meetings—keeping the federal funds rate target between 4.25% and 4.5%. Currently, traders generally expect Fed policymakers to implement the first rate cut of 2025 in September.
In fact, the risk factors that make the Fed unwilling to cut rates early have been present and are still accumulating.
On April 2, U.S. President Trump announced a 10% base tariff on most imported goods, and during the 90-day suspension period for reciprocal tariffs he set (which will expire in July), this trade war still lacks a permanent solution, exacerbating the uncertainty regarding the inflation outlook. Additionally, the conflict between Israel and Iran, which erupted late last week, has continued into its fifth day, leading to increased oil price volatility and raising concerns about a new wave of inflation triggered by supply disruptions.
Greg Faranello, head of U.S. rates trading and strategy at AmeriVet Securities in New York, stated that market participants will react to the 'dot plot and how it relates to the Fed's inflation forecast' on Wednesday.
Faranello pointed out that if the Fed's latest dot plot forecasts only one rate cut in 2025, it may be seen as 'more hawkish' and could lead to a rise in short-term rates (such as the 2-year Treasury yield), which would become a buying opportunity for some investors.
Faranello wrote that U.S. Treasury yields have been oscillating in a range for about two months, and participants in the interest rate market have said, 'We don’t know what will happen next.' Faranello also mentioned that the Fed may not cut rates at all this year.
Faranello believes that, compared to the expectations for interest rate direction this year reflected in the dot plot, traders may not pay much attention to the Fed's updated interest rate forecasts for 2026 and 2027, as there is too much uncertainty regarding the inflation outlook, and they may respond more cautiously to Powell's press conference, as the Fed chair's term will end next year and Trump will seek a successor.
"The overall trajectory of interest rates will definitely decline, that is certain. The question is how quickly we will achieve this," the strategist added.