A Fresh Start
The Federal Reserve (Fed) held rates steady at Chair Warsh’s first meeting of the Federal Open Market Committee (FOMC) amid an improving growth and labor market outlook.
Key takeaways
- Markets expect no change, with only one hike priced by March 2027. The bond market’s outlook for Fed policy has shifted from how many cuts to whether they remain on hold or are forced to deliver a hike.
- Inflation has been stubborn and is likely to remain elevated for the next quarter, with higher commodity prices and weaker base effects expected to help the headline numbers move lower.
- Consumption is strong, though with a deteriorating savings rate. The question is, are we borrowing from the future?
Federal funds rate stays at 3.50–3.75%
Today, the FOMC announced it kept interest rates unchanged, holding the federal funds rate at 3.50–3.75%. Market consensus has priced in only one hike by March 2027. While this is a shift from one cut being priced ahead of the last meeting, the expectation is for nothing to materially change from here. The wider macroeconomic data is mixed; the labor market remains in a slightly more positive balance, despite a strong nonfarm payroll for May. In contrast, in April, the U.S. workforce fell below 170,000 for the first time since December 2024. This is the highest annual decline we have ever seen through the three months to April, outside the Global Financial Crisis and COVID pandemic.
The consumer has surprised to the upside, maintaining robust growth of around 2% quarter over quarter but with a falling savings rate. Growth expectations have begun to reprice higher, with investment and consumption both balanced nicely. Inflation, on the other hand, has proved stubborn and is likely to continue to pick up from here. Tariff uncertainty remains, including a small left tail risk that a “resolution” in the geopolitical backdrop could open a flood of demand.
The Fed’s balance sheet remains a central question and will increasingly be in focus over the next few Fed meetings. Markets will continue to watch the chair as he implements his vision for the FOMC, which may see subtle shifts in the communications process and provisioning of data. The market will be keenly looking for these signals.
A focus shift from inflation to growth?
The core Consumer Price Index rose to 2.9% year over year in May, while the (old) Fed’s preferred measure, the core Personal Consumption Expenditures, won’t be released until June 25 but saw April come in higher at 3.28%. Historically, the FOMC has looked through energy-driven inflation impacts, treating them more like a one-time effect.
That said, U.S. growth remains steadfast and continues to benefit from the artificial intelligence build-out. The Atlanta Fed gross domestic product (GDP) nowcast has GDP at 3.3% for the second quarter of 2026 (down from the lofty 4.3% in May) but still strong. A reduction in geopolitical tensions may ultimately see a wave of further demand being unlocked.
Opportunities abound
The U.S. remains one of the strongest economies for now, and we believe a reduction in geopolitical tensions could unlock another gear for growth. The narrative of “run-it-hotter” U.S. fiscal policy is likely to persist. Together with relatively easy monetary policy, we believe growth-sensitive assets have the potential to do well in this market environment, and we see potential for good carry from bonds.
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Duration is a measurement of the sensitivity of a bond’s price to changes in Treasury yields. A fund’s duration is the weighted average of duration of the bonds in the portfolio. Duration should be interpreted as the approximate change in a bond’s (or fund’s) price for a 100-basis-point change in Treasury yields. Duration is based on historical performance and does not represent future results.
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The Consumer Price Index is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services. You cannot invest directly in an index.
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