Tomorrow’s Fed policy meeting decision is unlikely to throw up any surprises, with the market having priced out any chance of a hike. The real focus will be on the language of the accompanying statement.

The market has arguably already priced in the possibility of a slightly less dovish Fed, with US yields at a one-month high. The US labour market remains robust, inflation expectations have ratcheted up, as have house prices. Chinese economic activity has picked up and global equities and commodity prices have surged in the past couple of months.

But the Fed is also likely to reiterate its concerns about slowing global growth, US business investments and exports and the headwind to US growth from the manufacturing sector. This nuanced picture is summarised in the heat-maps in Figures 5 & 6.

Moreover, the Fed has made clear it would look beyond potentially temporary developments and could well play down the recent rebound in global energy prices and in major economies such as China.

I therefore expect the Fed to be constructive enough tomorrow to keep US yields in reasonably narrow ranges but to stop short of encouraging a significant repricing for a June hike.

This remains a challenging balancing act for the Fed as equity markets and non-commodity currencies have been flat-lining recently. If the Fed intensifies its dovish warnings, markets could start looking more closely at what is keeping the Fed from delivering only its second hike in a decade. Conversely, a more hawkish stance could spook a market attuned to dovish Fed rhetoric.

My core scenario remains for the Fed to hike rates once or twice this year, which would be sufficient to expose the soft under-belly of EM currencies.

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