Fog in front of Fed gets thicker

The only real question going into the Federal Reserve meeting last week was how much impact the war against Iran would factor into decision-making. The answer came in the Federal Open Market Committee (FOMC) statement: “The implications of developments in the Middle East for the US economy are uncertain.” Chair Jerome Powell even acknowledged that the updated Summary of Economic Projections (SEP) should be taken with a grain of salt.

But FOMC members seemed to look through current events and left the fed funds rate unchanged in the 3.5-3.75% range. In the Summary of Economic Projections, they again forecast one rate cut this year. However, they did nudge higher their growth and inflation projections in 2026 and 2027, with longer-run GDP growth moving from 1.8% to 2.0% and the fed funds target rate moving from 3.0% to 3.1% starting in 2027.

The prospect of higher inflation — "somewhat elevated” in Fed parlance — was confirmed by recent economic data that showed the core Personal Consumption Expenditure inflation (Core PCE, which removes volatile elements such as energy and is the Fed’s preferred inflation gauge) rising from 3.0% to 3.1%, boosted by the tariff impact on the goods sector. Wholesale costs rose more than expected, with the Producer Price Index rising 3.4% over the last year, up from 2.9% in last month’s reading. Goods, services, food and energy prices all contributed to the rise, important since these data were for February, before the Iran war started. Higher oil prices surely will push up near-term inflation and likely crimp growth, but it is too soon to know how long the “near term” will be. Powell affirmed the Fed’s commitment to its 2% inflation target but admitted that the pandemic, tariffs, and now the Iran energy shock, have delayed its progress. In short, it appears the Fed will be on hold for some time, unless growth falters, unemployment rises sharply or core goods inflation shifts notably.

Markets responded bearishly, as both equities and bonds sold off. The Treasury yield curve bear-flattened (yields on two-year notes rose more than those of longer-duration bonds).