FOMC Holds Rates Steady; Drops Easing Bias By Ending Forward Guidance

— SEP Shows Fed Officials See Funds Rate Rising To 3.8% By End ‘26; Back to 3.6% end ’27

– -SEP Inflation Forecast Lifted for 2026 From 2.7% to 3.6%

— Warsh Didn’t Submit Funds Rate Dot; Half Want Rate Same or Lower; Half Want Rate Hike

– -Warsh Committed To 2% Inflation; ‘Compatible’ With Strong Growth, Low Unemployment

– -Warsh Devalues Use of ‘Forward Guidance’ On Monetary Policiy

By Steven K. Beckner

(MaceNews) – Although it left short-term interest rates unchanged Wednesday, the Fed’s policymaking Federal Open Market Committee did make a significant change in its policy statement by removing a six-month-old bias toward a resumption of rate cuts.

What’s more, FOMC participants anticipated the funds rate will end this year higher than they had previously projected and higher than the current funds rate level, but only modestly so.

With aspiring rate slasher Kevin Warsh in the chair for the first time, the FOMC held the key federal funds rate steady in a target range of 3.5% to 3.75% for the fourth straight meeting, and it abandoned an easing bias that had been in place since the FOMC last cut rates in December.

Meeting closely on the heels of an announced Middle East peace settlement that sent oil prices tumbling and seemingly brightened the inflation outlook, FOMC participants were relatively restrained in their interest rate projections,

In their revised, quarterly Summary of Economic Projections, 18 FOMC participants projected the funds rate will go to a median 3.8% by the end of this year, up from the current median of 3.6%. They anticipate it will return to the present level by the end of next year and to 3.4% at by the end of 2028.

But officials were anything but united. The SEP “dot plot” shows eight officials projected an unchanged funds rate through 2026, while one anticipated a 25 basis point rate cut. Nine projected a rate hike. Warsh revealed that he did not participate in the SEP exercise, although he said he may do so in the future.

As he pointedly noted in his inaugural press conference, the Fed governors and Reserve Bank presidents were evenly divided between those who wanted a rate hike and those who did not, and he said there was considerable “humility” among the 18 officials in making their projections and forecasts.

In abandoning its easing bias in a streamlined policy statement, the FOMC did not so much change its “forward guidance” as eliminate it. Gone is this key sentence: “In considering the extent and timing of additional adjustments to the target range for the federal funds rate, the Committee will carefully assess incoming data, the evolving outlook, and the balance of risks.”

That sentence, which had been widely seen as carrying a presumption that the FOMC’s next rate move would be lower, was increasingly seen as inappropriate by Fed officials, three of whom dissented against retaining it on April 29.

Warsh said he does not view forward guidance as very useful, and declined to give much guidance on the future rate path in response to reporters probing him on when or how the FOMC might move.

By abandoning its easing bias and increasing projected rate levels, the FOMC is bound to feed speculation that its next move will be to make monetary policy more restrictive. But whether the Fed will soon follow the European Central Bank and others in actually raising rates this year is very much open to question at this juncture.

Warsh declined to say how he thinks monetary policy should move, beyond repeatedly reiterating the Fed’s commitment to 2% inflation. But he suggested that the outlook for inflation could change considerably between now and the FOMC’s next meeting of July 28-29.

“I reviewed the dot plots. and when I saw the submissions, I noted that all the submissions were coming in with pencils — those kind with the big erasers,” he remarked. “That’s to say that I think my colleagues around the table when they submitted their dots understand the world is changing quite quickly. And they didn’t feel bound by them six weeks from now or six days from now. And if any event the circumstances change.”

“I’ll note a couple other things,” Warsh continued. “What I heard around the table was — as they submitted their forecasts — to be clear, they weren’t saying this was more likely than not. This was more likely than their other scenarios. So I didn’t hear tons of conviction. What I heard was the kind of humility that I think we should have.”

In the economic forecasts accompanying their rate projections, Fed officials further increased their forecast of inflation, as measured by the price index for personal consumption expenditures (PCE), to 3.6% by the end of 2026 – up from 2.7% in the March SEP and from 2.4% in the December SEP. Core PCE inflation is forecast at 3.3%% in 2026, up from 2.7% in March.

Asked whether those higher inflation forecasts were based on the impact of the Iran war, as opposed to more underlying inflationary forces, Warsh responded, “My read of what I heard in the room reflected, I must admit in the SEP is half of my colleagues thought the policy rate, given those  developments, should be at this level or lower between now and year-end and the other half thought higher. That 19th voter was me and I didn’t submit.”

“There’s a range of questions on first and second-round effects,” he went on. “No resolution or conviction. But we’ll be meeting again in six weeks. I think we’re going to know more then. And I think that my colleagues are very attentive to  incoming developments between now and then.”

Warsh declined to call monetary policy overly restrictive, belying the “dovish” reputation he had built prior to his nomination, calling it only “somewhat restrictive” in some sectors,  but “uneven.”

The sharply higher inflation forecast led a slim majority to project a modestly higher funds rate, but recent developments could change the inflation outlook, Warsh hinted.

Before the U.S.-Iran peace deal, rising oil prices had caused financial markets to significantly bid up odds of a rate hike by year’s end. But since the yet-to-be finalized “memorandum of understanding” was announced, oil has fallen from a high of $127 to below $76 per barrel for Brent crude. The average price of gasoline has, in turn, fallen 50 cents per gallon from a month ago to just over $4.00 per gallon, seemingly promising relief from inflationary pressures. 

However, as promising as the “deal” may sound, it has not been finally signed, much less fully implemented. So, plenty of uncertainty remains for the Fed to navigate, as the truncated FOMC statement indicated. “Inflation remains elevated relative to the Committee’s 2% goal, in part reflecting supply shocks that have driven price increases in certain sectors, including energy.”

Preceding that assertion, the FOMC statement said, “Economic activity is expanding at a solid pace despite elevated uncertainty that owes, in part, to the conflict in the Middle East. Productivity growth and capital investment are strong. Job gains have kept pace with the workforce, and the unemployment rate has changed little.”

In place of the deleted easing bias, the new statement simply says, ”The Committee decided to maintain the target range for the federal funds rate at 3-1/2 to 3-3/4 percent, in support of the Federal Reserve’s dual mandate. The Committee reaffirmed its policy of maintaining ample reserves in the banking system.”

Warsh said the boiled down policy statement may well be just the first of a number of changes in Fed communications, including possibly the SEP. He announced the creation of five task forces to tackle that and other issues as he seeks to “move the Fed forward.”

Although the new Fed chief downgraded the usefulness of “forward guidance” on rates, the change in wording on the funds rate seems sure to be seen as a major shift in the Fed’s policy predisposition at a time when upward pressures on inflation had led Wall Street to sharply increase the odds of a rate hike later this year.

Although the FOMC did not explicitly lean toward higher rates, the shift from easing bias to no bias sends a powerful signal, since reversals in the direction of rates have traditionally been preceded by the FOMC taking the intermediate step of moving to a symmetrical policy statement.

Former Fed Chairman Jerome Powell said in April that, before actually raising rates, the FOMC would first move from an easing bias to a “neutral” stance, then later adopt a tightening bias if it decides upside inflation risks continue to predominate over downside employment risks.

Up until the “deal” with Iran, risk management considerations for the Fed were moving unfavorably. Leading up to this meeting, the FOMC had gotten a surprisingly strong employment report along with a string of worrisome inflation reports, most recently a 4.2% year-over-year May increase in the Consumer Price Index and a 6.5% rise in the Producer Price Index.

The duration of above-target inflation and the threat it poses to inflation expectations were also a big concern. The fact that inflation has been above target for more than five years has repeatedly been cited by Fed officials, who see it as a threat to the central bank’s credibility.

With the economy showing no apparent need of monetary stimulus and with inflation showing a need for more monetary restraint, rate cuts came to be seen as a virtual impossibility unless labor markets unexpectedly weaken and/or if the inflation outlook significantly brightens, although some officials are more open to them than others.

The new glimmer of hope, which tends to keep the Fed sidelined for the time being, is that an end to the Iran war could suppress energy costs and put inflation back on a downward trajectory. But there is too much uncertainty about energy and tariff effects for the Fed to count on a resumption of disinflation, as Warsh made clear.

It helps the easing cause that various measures of underlying inflation look much less scary. The “core” CPI was up just 2.9% year-over-year in May. The Dallas Fed’s trimmed mean price index is up just 2.3% for the past year, as President Lorie Logan recently noted. But the Fed is primarily wedded to the core PCE.

The 17^th Fed chairman, Warsh had a reputation as an inflation “hawk” when he was on the Board of Governors 2006-2011, resigning out of opposition to what he regarded as inflationary “quantitative easing.” But more recently, as he competed with other candidates for the top Fed job, he took a dovish turn, arguing that faster productivity growth should restrain inflation and allow the Fed to lower interest rates, which happened to be just what President Trump wanted. In congressional testimony, Warsh vowed to protect the Fed’s independence and not be a “sock puppet” for Trump, but he will be under close scrutiny to see if he lives up to that pledge.

In his first press conference, he chose his words carefully as he sought to establish himself as the U.S. central bank’s new leader.

“We recognize that inflation has been running well ahead of the Fed’s long-stated inflation goal of 2%,” Warsh said in an opening statement. “That’s been going on for more than five years.”

“Persistently high prices are a burden for the American people,’ he continued. “But the recent past need not be prologue. I am pleased to report that members of the FOMC are unambiguous and unanimous. This committee will deliver price stability.“

Asked how restrictive he thinks monetary policy is, Warsh hedged.

“I’ve heard characterizations both inside the Fed about that,” he replied. “I’ll give you my own. It’s uneven.”

“If I look at the housing markets as one example, Fed policy isn’t the single determinant of the state of the housing market, but broadly, I would say there, Fed policy appears to be somewhat restrictive,” Warsh elaborated. “I would have a hard time managing to say those words if I were to see what’s happening in financial markets.”

“I’d say it’s uneven,” he repeated. “That’s perhaps a function of different transmission mechanisms of monetary policy, whether monetary policy is coming from our interest rate tool or our balance sheet tool. But the good news is we have a task force on that, the balance sheet task force will look more at that subject.”

Warsh said there is “no reason” for the FOMC to revisit its 2% inflation target, saying again that he and his colleagues are committed to hitting that target.

But he did mark a departure from the past emphasis that many Fed chairmen have put on the so-called Phillips Curve trade-off between inflation and unemployment.

“I don’t believe that we have a cruel choice,” he declared. “I don’t share the view that was expressed a few generations ago that Federal Reserve chairmen show up at a podium and say you’ve got to choose. And you’re going to have to decide whether you’re willing to tolerate higher inflation to put more people at work. I don’t believe in that.”

“What I believe is if we do our job, we can make strong growth, low prices, and strong employment mutually compatible,” Warsh continued. “So what you heard from the Committee today is we’ve got some work to done the price stability front. “

In the current environment, he said the Fed’s job is “to make sure that those changes in oil, or beef, or eggs, or milk don’t  broaden in the economy, don’t have second and third-order effects. That’s our commitment, our capability, and we’re going to deliver on it.”

Warsh also struck out in a new direction on Fed communications and the financial markets reactions to those communications, which some have characterized as tail chasing.

“I think financial markets perform best when they react to incoming data,” he said. “I think the financial markets work less efficiently when they ask a question, how will the Federal Reserve react to that incoming information.”

“The more that markets are paying attention to what’s happening in the real economy, deciding what’s good data and what’s less good data, the more financial markets can price what they believe is the most likely and what are the tail risks,” he continued. “Financial market prices are probably the most important source of information to guide central bankers.”