The decision comes shortly after the United States and Iran reached a framework agreement to reopen the Strait of Hormuz, which led to a drop in energy prices.
Following a meeting deemed crucial for assessing the stance of the US Federal Reserve (Fed) and that of its new chairman, Kevin Warsh, the US central bank announced its decision regarding the policy rate on Wednesday. In line with market expectations, the Federal Open Market Committee (FOMC) kept rates within a range of 3.5% to 3.75% for the fourth consecutive meeting.
During a press briefing, the new Fed chair nominated by the Trump administration emphasized that the institution intends to bring inflation back within the desired range. “Inflation remains elevated relative to the Committee’s 2 percent goal, in part reflecting supply shocks that have driven price increases in certain sectors, including energy. This situation has been going on for more than five years, and the continued rise in prices is taking a heavy toll on Americans,” Mr. Warsh said. The members of the Monetary Policy Committee “are unequivocal and unanimous” on this issue, he added.
Based on projections updated on Wednesday, half of the Fed members now expect a rate hike before the end of the year. The other half expects rates to remain unchanged, while one member anticipates a slight easing. Meanwhile, the average inflation forecast for 2026 has been revised significantly upward, from 2.7% last March to 3.6%.
The Fed now expects economic growth of 2.2% this year, down from 2.4% in its March forecast, and inflation excluding food and energy of 3.3%, up from 2.7% previously. The unemployment rate is also expected to stand at 4.3% by the end of the year, down from a previous estimate of 4.4%.
Our Observations
The first Federal Reserve press release under Kevin Warsh marks a clear shift towards “supply-side economics.” It emphasizes strong productivity growth and business investment, while attributing inflation mainly to sector-specific supply shocks such as energy. This significant change illustrates how Mr. Warsh interprets the data of the current economic cycle, and how he managed to convince the Committee to adopt this narrative, with no dissenters.
Productivity growth is unusually strong relative to real GDP growth, with their ratio reaching 100%, a rare occurrence in this phase of the economic cycle (expansion with low unemployment rate). Combined with moderate wage gains, this suggests that the labour market is not inflationary. In fact, average hourly earnings adjusted for productivity growth are now at just 0.5%. There is nothing inflationary about this; on the contrary, the labour market is pushing inflation down well below the official target of 2.0%.
Despite this, the Fed sharply revised its inflation forecasts upward, particularly for core PCE inflation, now projected at around 3.3%. While higher total inflation due to energy trends is understandable, the increase in core inflation forecasts is more surprising. This means that the Fed went from forecasting disinflation to forecasting reflation, also implying that price stability in the United States would not be reached for six years in a row.
Historically, a 0.5 increase in core inflation has been rare and associated with specific conditions. In 2000, the US economy was experiencing serious overheating, with real GDP growth exceeding productivity growth by 2.0 percentage points. By 2010, the economy had experienced a significant reversal, with 2009 showing an extreme disinflation dynamic of -1.0 percentage points. In 2021 and 2022, the biggest monetary policy mistake ever was made after a policy rate that was too low for too long, coupled with the Fed printing extremely large amounts of money. But why would a 3.5-month oil price shock cause such a large response in inflation outside of energy this year, in 2026?
Today’s core PCE Fed forecasts do not exclude any relative price shocks. The Fed’s inflation forecasts are inconsistent with our inflation fundamentals, i.e., the three powerful disinflationary factors currently at play (housing, tariff reversal effects and unit labour costs), especially if oil prices continue to fall. Moreover, the Fed’s inflation forecasts do not consider the upcoming conclusion of the task forces announced today. We believe this is the most important point of all, as these forecasts could change drastically going forward.