The Federal Reserve kept its short-term policy rate unchanged at 3.50%-3.75%.
This was the first meeting under new Fed Chair, Kevin Warsh. While the decision was widely expected, the Committee has developed a hawkish shift to its dot plot released in its Summary of Economic Projections. Despite elevated inflation, the new Fed Chair remains determined the FOMC will deliver on its price stability mandate. Over the course of the year, the case for lower rates has been made more complicated by not only elevated inflation, but also a surprisingly resilient labor market. At the start of the year, markets mostly expected the Fed to maintain a dovish stance, with one or two rate cuts expected through 2026. However, the conflict in the Middle East and the resulting disruption to energy supplies stalled and even reversed much of the progress made on the inflation front. After three consecutive months of strong employment growth, the market now largely expects at least one rate hike before the end of the year.
Has the conflict in the Middle East impacted Fed policy?
The US and Iran reached a deal to end the conflict that began Feb. 28. Energy prices fell on the news and are well below the highs reached during the peak of the conflict, yet remain above levels seen prior to the closure of the Strait of Hormuz. Over the course of the conflict, higher energy prices have resulted in increased prices in natural gas derivatives as well as elevated prices across a range of sectors being affected by limited access to materials. All of this has resulted in not only higher headline inflation, but also the Fed’s core inflation reading.
The Fed will tend to look beyond geopolitical effects on inflation, however, as it tends to be short term in nature. While a deal was reached, a lot of uncertainty remains — the terms of the agreement may change and the risk the agreement does not hold cannot be completely ruled out. Inflation may remain elevated in the months ahead. If the agreement holds, however, and lower energy prices are sustained, inflationary pressures will subside as will the perceived case for rate hikes.
What else is impacting Fed policy?
There are various means of stimulating or slowing the economy. The most effective, typically, is adjusting short-term interest rates up or down to achieve the Fed’s inflation and employment goals. The Fed would look to raise rates in an environment of higher inflation expectations or unexpected labor market strength. As of mid-June, inflation expectations remain near the Fed’s long-term target (as measured by the 5-Year, 5-Year Forward Inflation Expectation Rate). While inflation has remained elevated since the pandemic, the market has continued to expect that inflation will eventually return to the long-term rate of approximately 2.0%. The FOMC Chair helped affirm this goal in his press conference comments that the Committee will deliver on price stability.
While the unemployment rate has remained stable, and low relative to historical standards, May’s job report (released on June 5) was the third consecutive month of +100,000 jobs added. This report quickly fueled concerns by the market that the Fed would raise rates in a future meeting. Markets sold off, with the tech-heavy Nasdaq declining more than 4% intra-day following the report’s release.
Inflation measures recently hit a three-year high, driven largely by rising energy prices as a result of the conflict with Iran. While elevated inflation is expected to be short term in nature, inflation has remained above the Fed’s 2% target for five years and is largely expected to remain elevated through at least the remainder of this year. Despite consumer spending remaining relatively strong, the effects of prolonged and higher inflation are starting to be seen. Credit card delinquencies have risen over the course of the last several months, personal savings rates are declining and real wage growth is now negative (inflation levels have exceeded wage growth for the second consecutive month). Raising interest rates could compound these effects, putting upward pressure on the unemployment rate, downward pressure on consumer spending and downward pressure on economic growth. These factors taken together have the Fed in a precarious position that could have adverse effects on economic growth if monetary policy were to become too restrictive.
How have markets performed?
Markets sold off following the Fed meeting on news that a rate hike may materialize later this year. Equity markets gave up their intra-day gain with the S&P 500 finishing down more than 1%, while the 2-year Treasury yield increased 15 bps to nearly 4.2%.
How have investment recommendations changed?
The economic backdrop remains relatively stable: the economy is expected to grow near trend levels in 2026, labor markets remain stable and the expectation is that inflation will decline in the months and years ahead. As inflationary pressures subside, the aforementioned risks to the consumer should also subside. Periods of volatility are to be expected as markets continue to navigate the current environment. We encourage investors to remain invested and take advantage of market selloffs, should they occur.
If you have questions about how to navigate this situation, please consult your Enterprise Bank & Trust Wealth Advisor.
This report and the analysis contained herein were prepared exclusively by the Wealth Management division of Enterprise Bank & Trust and reflect our internal market views.
Investments are: *Not FDIC insured *May lose value *Not financial institution guaranteed *Not a deposit *Not insured by any federal government agency.
