The FOMC is widely expected to keep the federal funds rate at 3.50-3.75% with no change to the statement. The base case is that this is going to be a non-event given the uncertainty around the Middle East situation and Powell’s final press conference.
The US data since the last FOMC meeting in March has been remarkably strong suggesting underlying economic resilience and even acceleration despite a more pessimistic future outlook caused by the US-Iran war and the Strait of Hormuz closure.
The Fed eased monetary policy in the second half of 2025 mainly due to a weakening labour market on worries that it could deteriorate faster and eventually cause a significant slowdown in the economy. In 2026, we’ve been getting better and better labour market data (excluding the February NFP), with continuing jobless claims and weekly ADP data showing a meaningful improvement.
This has led to a repricing in dovish expectations and eventually all the rate cut bets were erased once the US-Iran war broke out. The market is now seeing the Fed remaining on hold at least until July 2027.
On the inflation side, the Fed has been missing its 2% target since 2021 and the reluctance to adopt a clear hawkish bias kept the market in a dovish reaction function. Financial conditions never really tightened enough to bring inflation sustainably back to target. Inflation continues to run closer to 3% and the US-Iran war is expected to add more upward pressure.
On the growth side, the negative supply shock is expected to weigh on economic activity which is giving the Fed a reason to stay on hold for longer as rate hikes wouldn’t resolve the root cause of inflation (Strait of Hormuz closure).
The problem for the Fed would be rising inflation expectations. In the markets, there’s already a consensus view that the Fed has abandoned its 2% target and it’s now basically uses a range framework like the RBA keeping inflation between 2 and 3%. They are not determined enough to squeeze it back to 2% if it means more labour market pain.
If the US-Iran stalemate were to extend for much longer keeping oil prices around triple digit levels, inflation expectations could start feeding into higher wage growth if financial conditions remain loose and the economy stays resilient. That could turn into an even uglier situation once the US-Iran war is resolved as economic activity would pick up strongly and substitute cost-push with demand-pull inflation.
This brings us to Powell’s final press conference as Fed Chair. The expectations are for him to remain neutral and not offering any forward guidance to give the next Fed Chair (Kevin Warsh) flexibility. Even though Powell has been undoubtedly a great Fed Chair who had to navigate lots of economic shocks, he has failed his mission of bringing inflation sustainably back to target.
I hope he remains on the board until 2028 and helps his colleagues with the last mile. The next chapter is not going to be about Warsh, it’s going to be about the FOMC. The board will have more influence than the Fed Chair on markets expectations, and Fed Watching skills are going to be very valuable
