Sluggish inflation has made the Federal Reserve's efforts to get interest rates back to normal levels a lot harder.
The Fed is expected to raise interest rates Wednesday by a quarter point, and it has forecast another rate hike for this year. But the recent slowdown in inflation has become a red flag for markets, which doubt the Fed's ability to hike a second time before year end.
The Federal Open Market Committee is expected to raise the fed funds target rate to 1 to 1.25 percent.
Fed Chair Janet Yellen holds a post-meeting briefing and is expected to provide some more detail on the Fed's $4.5 trillion balance sheet. The Fed hopes to begin shrinking that balance sheet this year by scaling back a program to replace Treasury and mortgage securities as they mature.
Inflation will already be top of mind for markets Wednesday, even before the Fed's 2 p.m. statement. The consumer price index is released at 8:30 a.m. ET, as is the latest retail sales report. That CPI report is expected to show that May core inflation was running at an annual rate of 1.9 percent, the same as April. CPI fell below 2 percent in April for the first time since late 2015.
The Fed's preferred inflation measure, the PCE deflator, also came in at a weaker 1.5 percent, well below the Fed's 2 percent inflation target.
"I don't think inflation coming off is going to alter the current upward trajectory for rates right now," said Chris Rupkey, chief financial economist at MUFG Union Bank. "I don't think we're going to take one or two rate hikes off the table for the next one or two years. I think they're going to stick with the game plan.
"It's still premature to say they need to alter their policy," Rupkey said. "The basic textbook theory is that unemployment is lower than where it should be normally, and in these circumstances, inflation can gain a foothold if they don't normalize rates. It's really theory trumping the actual economic data. I know they say they're data dependent. I don't think they're data dependent on inflation."
Rupkey said the markets will be watching both the inflation and retail sales data. Retail sales are expected to rise 0.1 percent, below the 0.4 percent last month.
"There was a soft patch for the consumer in the first quarter. It looked like retail sales were stronger a month ago," Rupkey said. "What if there's a new setback on consumer outlays? It could affect the market's thinking. The market could say: 'Sure, you have three rate hikes this year and for next year, but we don't see it now because the economy's not emerging from its slump."
Bob Doll, chief equity strategist at Nuveen Asset Management, said he expects a rate hike Wednesday, but he, like the market, sees about a 50 percent chance of another hike.
"I think that's going to be the most interesting part of the conversation," said Doll. "With economic growth not as robust as it might have been three months ago and inflation not rising like it was three months ago, there's a lot of great questions they have to answer: 'You're really going to do it again this year?'