Fed doves have spent months advocating for rate cuts. Now, they find themselves forced to defend the status quo.
"I see absolutely no reason to raise or lower rates at this time," John Williams, President of the New York Fed and a close ally of Jerome Powell, stated yesterday.
This shift in rhetoric alone illustrates the evolving discourse within the Fed. In a matter of weeks, the conflict in Iran has completely altered the economic outlook and reshuffled the pack of cards for the US central bank.
At the end of 2025, the Fed cut rates three times in response to employment risks and inflation that appeared to be gradually slowing. These same factors were expected to allow the Fed to continue monetary easing into 2026.
However, the opening months of the year have instead revealed a resilient labor market. In April, job creation reached 115,000, significantly above the 65,000 anticipated by economists. For the first time in a year, the US economy has added jobs for two consecutive months. Meanwhile, unemployment has remained steady at 4.3%.
Concurrently, the energy crisis triggered by the closure of the Strait of Hormuz has reignited inflation, with the rebound occurring faster than expected. This week, both Consumer Price Index (CPI) and Producer Price Index (PPI) data surprised to the upside. The CPI showed a 3.8% y-o-y increase, with the core figure (excluding food and energy) at 2.8%. The PPI came in at 6%, its highest pace since March 2022.
At the start of the year, a consensus existed amongst Fed members that the next move would be a cut, with the debate centered on timing. Now, the question is whether rates will need to be hiked.
While the dovish bias (the forward guidance signaling to the market that rates will eventually be cut) was still present in the April meeting minutes, it is highly likely to disappear in June. Indeed, three members voted against it in April, and the latest data is expected to rally a majority behind this position.
Even Christopher Waller, who had been one of the most proactive proponents of rate cuts since 2024, is now concerned about inflationary risk. In a speech titled "One Transitory Shock After Another," delivered in mid-April, Waller emphasized that the Fed cannot ignore an energy crisis, which, it should be said, however, typically only has temporary effects on inflation.
Inflation has indeed remained above target for over five years. Inaction risks unanchoring inflation expectations as businesses and consumers grow accustomed to a higher inflationary environment.
The hypothesis of a rate hike appears to be gaining traction daily. According to the CME FedWatch Tool, the probability of at least one hike by year-end stands at 49%. The Fed would thus follow other major central banks - the ECB, the Bank of England, and the Bank of Japan - which are expected to begin raising rates as early as June.
In the markets, US. Treasury yields are at their highest levels of the year. The 10-year Treasury yield crossed the 4.5% threshold this week. The 2-year yield, generally considered a proxy for Fed policy expectations, is at its highest level since last June. At that time, Fed funds rates were... 75 basis points higher.
