Fed: Rates Held at 3.50-3.75%, But an Increase Now Looms in 2026

A Fourth Standstill, but a Shifting Dot Plot

The decision itself did not surprise the markets: the fed funds rate range remains set at 3.50% to 3.75%, in line with expectations reported by Bloomingbit. This marks the fourth consecutive hold. The shift is elsewhere, in the individual projections of the FOMC members.

In March, the central scenario was still betting on a rate cut within the year. The new dot plot reverses this trajectory: a majority of members now anticipate at least a 25 basis point increase by the end of 2026 if inflation remains above target. The statement simultaneously removed language suggesting future cuts and emphasizes bringing inflation back towards 2%.

These projections remain indicative and subject to revision as new inflation and employment figures emerge: they do not constitute a firm commitment to an increase. Moreover, Kevin Warsh has refused to publish his own rate forecast, signaling a clear intention to lessen the emphasis on forward guidance in the Fed's communication.

Inflation at 4.2%: A Primarily Energy-Induced Shock

The macroeconomic context sheds light on this shift. Overall CPI inflation stands at 4.2% year-on-year in May, compared to 2.9% for core inflation, excluding energy and food. The gap between the two measures confirms the predominantly energy-driven nature of the shock.

The Fed itself acknowledges in its statement that the price surge is largely linked to the increase in energy costs following the conflict with Iran and is therefore not very responsive to monetary policy. The recent trajectory of oil prices supports this view: Brent has fallen below $78 per barrel, after a drop of about 7% the previous day.

This decline partly reflects the anticipation of an influx of Iranian supply following the initial agreement signed between Washington and Tehran. However, its realization remains contingent on the effective implementation of the reopening of the Strait of Hormuz, the sustainable lifting of sanctions, and potential OPEC+ decisions, all of which could quickly reverse the trend.

What Investors Need to Understand About Long-Term Rates and Valuations

As long as the market must contend with the possibility of an additional increase in fed funds, a persistent risk premium may settle on U.S. long-term rates and the dollar. Mechanically, market segments most sensitive to monetary policy expectations (long-duration growth stocks, listed real estate, long-term sovereign bonds) remain exposed to repricing if inflation does not recede as quickly as hoped.

The pivot will largely depend on the trajectory of energy prices. A sustained decline in Brent and WTI would facilitate the mechanical return of the CPI towards the 2% target, while a security incident in the Strait of Hormuz or a failure of the U.S.-Iranian agreement would reactivate the geopolitical premium. Core inflation at 2.9%, closer to the objective, serves as a useful benchmark in distinguishing between a temporary shock and structural drift.

The backdrop remains one of still uncomfortable global inflation: the Eurozone saw its CPI accelerate to 3.2% in May according to Eurostat, and Fitch warns of a prolonged inflationary risk lasting until 2027 linked to the upcoming El Niño event. In this context, the Fed's shift occurs in a sequence where central banks maintain limited room to ease policy without risking a lasting re-anchor of inflation expectations.