Fed in no hurry to change rates, as economic uncertainty remains elevated

As meetings go, this Fed meeting was mundane. The Fed chair was careful to reinforce how uncertain the economic environment is, and he repeated the message that the Fed will remain on hold for the foreseeable. Fed chair Powell is happy with the current monetary policy stance of the FOMC, and also with the solid core economic data. He also expects an upward revision to the US Q1 GDP report, which may ease fears about US recession risks.

The Fed statement: Subtle shifts

The Federal Reserve remained on hold at this meeting, as widely expected by the market. The statement that was included with the decision had some subtle changes. The Fed is concerned about stagflation risks, saying that ‘the risks of higher unemployment and higher inflation have risen.’ The Fed statement did not mention tariffs directly, however, they noted the impact of them via economic uncertainty and upside risks to unemployment and inflation. The closest the Fed got to mentioning tariffs was talking about swings in net exports. However, on balance, the Fed sounded comfortable with their policy stance, and are firmly in wait and see mode. They are leaving the rate cuts to other central banks, including the Bank of England, who is expected to cut rates on Thursday.

No risk of a rate hike

The Fed chair would not be drawn on the timing of the next rate cut and batted away questions about the potential for a June rate cut. The Fed remain doggedly committed to data watching, and Powell said in his press conference that if inflation was to run so far above target due to tariffs, then it could get in the way of the Fed meeting its inflation goals. This could lead to a pause in the rate cutting cycle. Powell was careful not to say that rates could rise, but he said that the Fed has to balance the risk of unemployment rising, alongside inflation. For now, the situation of inflation and unemployment  being in tension, is a hypothetical only.

The market reaction

The market reaction initially saw stocks and risk sell off, however, like the Fed, traders and investors are also flummoxed by the current tariff/ monetary policy situation. The S&P 500 initially fell after the statement was released, but it managed to claw back some early losses. The mood was lifted as the Fed chair swerved mentioning the prospect of rate hikes, even though the Fed spoke about the upside risks to the outlook for inflation.

Both 10 year and 2-year Treasury yields were mostly unchanged during Powell’s press conference, although the 10-year yield fell slightly. There was a slight reduction in interest rate expectations, the chance of a rate cut next month has fallen to 20% from more than 30% on Tuesday, and the chance of a rate cut in July is now 62%, down from 67% on Tuesday. The market is still expecting  approximately 3 rate cuts from the Fed this year, however, if the economic data starts to show upside inflation risks, then we could see the chance of rate cuts this year get scaled back further. However, that is not a risk for today.

The Fed may not be able to stem the dollar decline

The small reduction in rate cut expectations is lending some support to the dollar, which is the best performer in the G10 FX space so far today. USD/JPY is higher by 0.8%, erasing some of the yen’s gains vs. the USD so far this month. We do not think that this meeting will dramatically alter the direction of the dollar, which we continue to think is vulnerable to further downside in the short term. However, the pace of losses might slow now that the Fed is focused on inflation. This means that CPI releases could be a trigger for market volatility going forward, as the Fed remains fiercely data dependent.

On balance, the Fed did not rock the boat today. Fed chair Powell did not meaningfully step into the tariff debate, or the debate around fiscal spending. The Fed was focused on economic data even more than usual, and they also sounded concerned about the elevated level of uncertainty in the economic outlook. Jerome Powell will have wanted a boring meeting, and we think that he achieved one. The Fed has all the patience in the world right now, so we all go back to data watching, and waiting for the outcome of tariff negotiations.