The Federal Open Market Committee, in its June 14 statement, said it expected inflation on a 12 month basis to remain below 2 percent in the near term but to stabilize around 2 percent over the medium term. "Near-term risks to the economic outlook appear roughly balanced, but the Committee is monitoring inflation developments closely," it said.
In the latest CNBC Fed survey, inflation expectations have fallen about 20 basis points for the next couple of years compared with the June survey, with the consumer price index forecast to rise 1.9 percent this year and 2.2 percent in 2019.
Lyngen said the Fed does not want to unsettle the markets, with either a more hawkish or dovish sentiment on inflation, ahead of an expected September announcement on its balance sheet.
"I think the Fed wants to leave the door wide open for a September taper and in so doing, they'll want to make sure the market doesn't further increase its sensitivity to the inflation numbers," he said.
The Fed has said it would begin to shrink its $4.5 trillion balance sheet by slowing the monthly purchases it makes to replace the Treasury and mortgage securities on its balance sheet, as they mature. The Fed has detailed how it will begin with a total $10 billion a month and raise it after three months, gradually increasing the tapering back of purchases. The balance sheet was built up with Fed asset purchases, or quantitative easing, during and after the Great Recession.
The Fed has primed the market to expect it to discuss the upcoming wind down of its balance sheet, but views are varied on how much it will say.
In June, the Federal Open Market Committee said it "expects to begin implementing a balance sheet normalization program this year, provided that the economy evolves broadly as anticipated." Some Fed watchers do not expect much change in the statement, but there was some speculation the Fed could be more specific about the timing.
"People are expecting it to be a sleeper announcement. Maybe [the Fed] wakes people up a little bit by saying, 'we are telling you in advance, we're going to start the wind down in September," said Chris Rupkey, chief financial economist at MUFG Union Bank.
Cabana said the Fed could give more details on the balance sheet normalization process, and the Fed could point to its September meeting or say it will take action soon. He said one risk, though small, is that it makes an announcement to move right away on the balance sheet.
"We assign pretty low odds to that. It seems the market is not anticipating that and it would likely be a surprise to the market, and a hawkish surprise at that," he said.