Key Takeaways
- At the June FOMC meeting, Chair Kevin Warsh and policymakers left the fed funds rate unchanged at 3.50%–3.75%, but rising inflation pressures and a firmer labor market suggest the Fed’s focus is shifting away from an easing bias.
- The FOMC faces a complex backdrop as Middle East-related energy risks, lingering inflation concerns and AI-driven demand pressures offset the fading effects of tariffs, reinforcing the case for a patient policy stance.
- Following the June FOMC meeting, markets have begun pricing the possibility of future rate hikes by late 2026 or early 2027, making short-duration and Treasury floating-rate strategies increasingly relevant if economic momentum persists.
Once again, the Federal Open Market Committee (FOMC) decided to remain ‘on hold’, keeping the fed funds trading range at 3.50%-3.75%. This result was largely expected by the markets. Of course, one of the more notable aspects to this gathering was that it represented Kevin Warsh’s first official policy meeting as Fed Chairman.
Unfortunately for Warsh and the other voting members, the current landscape leaves the policymakers in a challenging position. Uncertainty surrounding the potential impacts of the Middle East war continues to hover over the macro and inflation backdrops. However, even if you ‘filter out the headlines’ (not necessarily an easy task), the Fed is left with a changing economic and inflation setting compared to earlier this year.
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Indeed, not only have price pressures been visibly escalating at both the wholesale and retail levels, but the labor market appears to be in better shape than was previously thought during the winter. While Warsh & co. may attempt to ‘look through’ the recent increases in various inflation gauges, they could be doing so at their own peril. Tariff-related influences seem to be trailing off, and higher energy prices should be reversed to some extent if hostilities were to cease in the Middle East and the Strait of Hormuz were to fully open. However, the Fed needs to be on alert that the impact of higher energy costs could be spreading to the broader macro landscape. In addition, demand pressures from the massive AI-related build-out need to be taken into consideration as well.
The ‘new kid on the block’ is the apparent rebound in new hiring. After some soft non-farm payroll data throughout the second half of last year, new hiring activity has picked up in a visible fashion since the last negative reading in February. As a result, the three-month moving average soared to +188k in May, giving rise to the notion that the ‘no hire, no fire’ labor market is now in a better state than previously thought.
Against this backdrop, both the Fed and the broader investment community have shifted their monetary policy expectations. From the FOMC’s perspective, the decision-making process will now feature a more balanced approach, rather than one that had retained an easing bias. On the other hand, the money and bond markets have moved into potential rate hike mode, with fed funds futures pricing a fed funds increase in by late 2026/early 2027.
In my opinion, the Fed is not ready to move into a policy geared towards rate hike(s). Interestingly, one of the changes Chairman Warsh wanted to make at the Fed was to modify their forward guidance mechanism, and it looks like this process has begun with a scaled back policy statement. This could make any potential policy shift from the Fed on the rate front less clear-cut than what the markets had become accustomed to from prior Fed Chairs.
The Bottom Line
Looking ahead, Warsh & Co. will be making monetary policy decisions based on the data, and barring any unforeseen circumstances, the base case scenario argues for a more patient approach to the decision-making process, with the Fed ‘on hold’ going forward.
Kevin serves as the Head of Investment and Fixed Income Strategy.
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