Outlook for US Fed's Interest Rate Decision in May: Maintaining Status Quo, Awaiting Policy Clarity

Following the stronger-than-expected April employment report, the market widely expects the US Fed to keep interest rates unchanged at 4.25%-4.50%. The money market currently believes there is only a 2% probability of a 25 basis point interest rate cut at this meeting, while the cumulative expectation for the year is a 72 basis point cut.

Following the strong US employment report last Friday, both Goldman Sachs and Barclays have postponed their predictions for the next rate cut from June to July. Notably, while Citi maintains its forecast of a 125 basis point rate cut for the year, it has delayed the timing of the first cut from May to June.

JPMorgan expects that the US Fed will keep its policy unchanged, with no substantive adjustments to the statement wording. The bank stated that the reason for the unchanged policy is clear, as Fed officials have emphasized the benefits of waiting before taking further action, even after "Liberation Day." JPMorgan expects no dissent in this decision, although Fed Governor Waller has become more dovish, his recent remarks do not provide a basis for preemptive policy easing. JPMorgan noted that in the subsequent statement, the description of the labour market as "solid" and inflation as "slightly above target" is likely to remain.

However, Morgan Stanley believes that the Fed may downgrade its assessment of economic activity, changing "continued solid expansion" to "slowing growth." Additionally, the FOMC may emphasize "increased risks to the dual mandate." Moreover, "Liberation Day" has not reduced economic uncertainty, and JPMorgan detailed that whether the FOMC wants to continue emphasizing that uncertainty "has further increased" or adopt wording like "remains highly uncertain" is a difficult question to judge.

Currently, much focus is on the impact of Trump's tariffs and the extent to which this impact has penetrated into the economy. There is a divergence between "soft data" and "hard data." Despite the US GDP slipping into contraction territory in Q1, labour market data has remained robust, showing no significant signs of weakness.

Overall, "hard data" remains resilient, while "soft data" paints a different picture, but the US Fed does not seem overly concerned about this unless these trends begin to be reflected in the "hard data." On the inflation front, the latest CPI and PCE data show a mild downward trend, in line with Morgan Stanley's expectations.

Goldman Sachs economists have highlighted two key points in their FOMC preview report. The first is "soft data" VS "hard data." The current data trend exhibits characteristics typical of an event-driven slowdown: survey-based "soft data" has deteriorated rapidly, particularly expectations for future prospects, while "hard data," which typically lags by about three months, has not yet fully weakened. Despite the sluggish performance of "soft data," Fed officials and investors are aware that in past years, "soft data" has falsely signaled recession risks for the US economy. Therefore, they prefer to see more supportive "hard data," such as from the labour market, before considering an interest rate cut.

The second point is a higher threshold for interest rate cuts. Goldman Sachs expects the target range for the federal funds rate (4.25%-4.50%) to remain unchanged, and the Fed is not anticipated to make significant adjustments to its balance sheet policy. Compared to the three consecutive interest rate cuts during the 2019 trade friction period, the Fed has now set a higher threshold for interest rate cuts. Given the current high levels of inflation and inflation expectations, the Fed will require stronger evidence of an economic slowdown and the necessity for interest rate cuts before taking action.

Prior to this meeting, many individuals, including Chairman Powell, insisted on "waiting for policy clarity" . However, other influential officials, including Waller , have leaned dovish, while Trump continues to exert significant pressure on the Fed to cut interest rates, repeatedly emphasizing that the Fed is moving too slowly.

Most officials believe that reciprocal tariffs will drive up inflation and curb growth, but Waller described the impact of tariffs as "temporary," while suggesting that an interest rate cut could be triggered by a rise in unemployment. Waller warned that if the US Fed waits to act until new policies are reflected in "hard data," it may be too late.

Mark Salib of Goldman Sachs Group stated, that one should tactically buy the US dollar, "We believe the FOMC will have a relatively small impact on the foreign exchange market, especially following the recent data flow. This week, the key focus is on the dynamics of the New Taiwan dollar and other Asian currencies. We have observed a significant appreciation of the New Taiwan dollar against the US dollar. Although there are currently tactical buying opportunities for the US dollar, intertwined factors such as capital repatriation may suppress the movement of the US dollar against Asian currencies, instead exerting pressure on the US dollar. It is currently difficult to determine whether this constitutes a sell-off of US dollar assets."

Dom Wilson and Vickie Chang of Goldman Sachs said, "We do not have a strong bias toward the US dollar. This is likely to be a rather mediocre US Fed meeting. Once we obtain more evidence on how tariffs affect inflation and growth, the US Fed's response will be more meaningful for the price movement of the US dollar."

Dom Wilson and Vickie Chang of Goldman Sachs Group stated, "The growth pricing model indicates that the market has fully priced in our baseline forecast but has insufficient cushioning against recession risks" (the US team still assesses the probability of a recession at 45%). In the absence of new catalysts, combined with the potential for short-term tailwinds from trade negotiations, the stock market and yields may continue to rise mildly, with volatility potentially compressing further."

However, in the medium and long-term, the downside risks of stocks and bonds are more dominant. Therefore, it is recommended to view any market easing as an opportunity to increase downside protection, especially for equity assets—the combination of higher inflation and lower growth will ultimately suppress stock prices.

Muhammad Umair, an analyst at FX Empire, stated that gold's daily chart remains within an upward channel, with the pullback from $3,500 finding support at $3,200 and recently facing resistance near $3,370 (coinciding with the upper boundary of the rising expanding wedge), with multiple bullish patterns confirming strong upward momentum.

The RSI indicator has rebounded near 50 and is approaching overbought territory, indicating solid buying support. However, caution should be exercised regarding RSI bearish divergence and the resistance signal from the upper boundary of the channel, which may trigger short-term pullback risks.If gold effectively breaks through $3,500, the upside target will point towards the $4,000 mark.