Editor's note: Jimmy Zhu is chief strategist at Fullerton Research. The article reflects the author's opinions, and not necessarily the views of CGTN.

The Federal Open Market Committee (FOMC) meeting earlier this week surprised many traders as the Federal Reserve, the U.S. central bank, planned to tighten its monetary policy earlier than previously forecast. 

Without specifying any details or plans ahead, the bank is likely to observe the volatility in the financial market in the next two months, causing the market to react quite negatively. If the volatility is largely contained, the central bank may lay out some details on quantitative easing (QE) tapering in the Jackson Hole meeting in August. 

The Fed released forecasts on its June meeting that show it expects two interest-rate increases by the end of 2023, faster than what markets expected earlier. Among the 18 Fed voting officials, 13 of them see at least one rate hike in 2023. Besides that, Fed Chair Jerome Powell said in a press conference that he would start to discuss the tapering of bond purchases, and the Fed upgraded estimates for inflation.

Those updates surprised most market participants, as many expected the Fed to keep a dovish stance in its June meeting. The market reacted quite negatively, all major equity indices declined, the bond yield rose most since March and the U.S. dollar rallied. Most importantly, the Fed conveyed a clear message: its monetary policy has been approaching a turning point, as its ultra-loose monetary policy may end within the year.

The Fed officials see their preferred measure of price pressures rising 3.4 percent in 2021 compared with a March projection of 2.4 percent. If the forecasts are to be realized, the number would be well above the Fed's inflation target of slightly above 2 percent. Such a prediction could be one of the main reasons the Fed had to inform the market that the central bank will need to tighten policies if inflation continues to accelerate. But markets have one question here: is this transitory or is it more permanent?

What the Fed predicts now is that core personal consumption expenditures (PCE) inflation for 2022 will be at 2.1 percent and will stay at that level in 2023. Those levels are just in line with the Fed's long-term inflation target, and it shows the Fed expects that current inflation levels are just transitory. Against this background, the Fed should have kept its previous dovish stance in order to further support the U.S. economy, instead of surprisingly shifting market views earlier this week that tightening is not far away.

The upcoming monetary path sounds very confusing, as the Fed also didn't specify any tapering details in its June meeting. In our opinion, the Fed may use the June meeting as an opportunity to convey a message to investors that a tapering discussion will happen very soon. On the other hand, the Fed will also keep an eye on market volatility, and officially introduce some details on the tapering plan in the upcoming Jackson Hole meeting in August, as long as volatility remains largely contained in the next two months.

Regardless of whether the first rate-hike by the Fed happens in 2023 or afterwards, it won't make much difference fundamentally. Most importantly, investors may need to start preparing for a tightening cycle in coming years. Stocks declined in the past few days after the Fed signaled it would taper bond purchases, and we expect the correction may last for some time before the economic recovery becomes more solid.

After all, gains in U.S. equities have been mainly driven by the Fed's mega-sized stimulus. Many traders are likely to sell some of their stocks purchased earlier before the volatility drops again. On the other hand, the European Central Bank (ECB) didn't mention anything regarding the bonds tapering in its June meeting. The policy divergence between the ECB and the Fed may send the dollar higher from current levels.

Over the past year, the dollar has been holding a high negative correlation with the stocks market, so a rising dollar is seen as a negative factor for the stocks market. Before the Fed clearly lays out its upcoming monetary policy path, U.S. stocks may find some difficulties moving higher in the near term.