New Projections
As anticipated, the Federal Open Market Committee held its benchmark federal funds rate steady in a target range of 4.25%-4.50% for the fourth consecutive meeting. With market pricing beforehand showing a near-zero chance of an interest rate move, investor focus immediately shifted to the quarterly Summary of Economic Projections (SEP). Here, the Federal Reserve painted a decidedly more challenging picture of the road ahead. The median forecast for 2025 shows real GDP growth cut from 1.7% to 1.4% and unemployment revised higher from 4.4% to 4.5%. Critically, expectations for core PCE, which strips out food and energy prices and is the Fed’s preferred inflation measure, saw an increase from 2.8% to 3.1%.Fed Summary of Economic Projections
The combination of both higher unemployment and higher inflation are the hallmark of stagflation, which can often strain monetary policy. Higher inflation would suggest higher interest rates to push back on inflation, but higher unemployment would suggest lower interest rates to support the economy. In this instance, the Fed split the difference and kept its year-end 2025 interest rate estimate steady at 3.9%, while lowering its 2026 rate cut expectation from two cuts to one cut — a subtle, but hawkish, signal.
Inflation Boogeyman
The Federal Reserve's heightened anxiety over inflation is not an isolated view. Across financial markets, investors and analysts broadly agree that price pressures are likely to make a comeback in the second half of the year. This shared view provides credibility to the Fed's hawkish stance, keeping volatility from getting out of control. Inflation swaps — derivatives used by institutional investors to price and hedge against changes in the Consumer Price Index — are showing that year-over-year inflation is expected to accelerate to 3.3% in November, versus the latest reading of 2.4%. The drivers of this fear are twofold. First and foremost is the uncertainty surrounding trade policy. The prospect of broad and sustained tariffs threatens to directly increase the cost of imported goods and disrupt global supply chains. That could fuel a new wave of inflation that may be too large and broad for the Fed to simply look past as a one-time shock. Second, intensifying geopolitical conflict between Israel and Iran has caused a spike in oil prices, a classic inflationary catalyst that can lead to higher costs for consumers at the gas pump and in air fares, electricity, and more.Oil and Tariffs Threaten the Disinflation Dynamic
This forward-looking anxiety is partly why investors largely shrugged off the cooler-than-expected May CPI report (the fourth downside surprise in a row). The inflationary impact of tariffs, which were only recently implemented, has yet to fully materialize in official statistics. For what it’s worth, Fed Chair Jerome Powell noted that “with uncertainty as elevated as it is, no one holds these rate paths with a lot of conviction” and "we feel like we're going to learn a great deal more over the summer about tariffs.”
That sounds like a recipe for a status quo monetary policy until more information is available, seemingly ruling out a July rate cut, barring a major surprise.
Market Stalemate
Market price action around the release of the Fed statement was interesting, as for a brief moment, it looked like investors were ready to fight the Fed (a market no-no). Immediately following the 2 PM announcement, yields on 2-year Treasurys dropped 4bps. This knee-jerk move suggested the market was initially focusing on the Fed's gloomier economic forecasts, betting that weaker growth and higher unemployment would ultimately force the central bank to cut rates more aggressively than it expected to. That narrative shifted during Powell's subsequent press conference and hawkish tone. It became clear that the Fed was in no rush to act. He stated that they were already beginning to see some tariff effects, but that officials would wait until the full impact became clearer — a direct counter to investors’ initial dovish reaction. Treasury yields began steadily rising, with the 2-year yield basically back to where it was before the statement was released and effectively unchanged from the previous day. The situation was similar for stocks. The S&P 500, up about 0.3% before the meeting and as much as 0.5% after the statement release, ended the day a whisker below where it began.Intraday Price Action
For investors, the key takeaway is the state of indecision gripping the market. The initial drop in bond yields, the ensuing reversal, and the bumpy final hour of trading all reflect the uncertainty around accurately forecasting in what is an unprecedented environment. Will tariffs eventually be wiped away, stay at current levels, or be ratcheted higher? And beyond the effective tariff rate itself, will consumers or businesses bear the burden of paying the added tax on goods?
Rather than navigate this landscape of unanswerable questions, the path of least resistance for investors may be, for now, to simply stand still.
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