After months of concern regarding a slowdown in the labor market, the Fed's focus has clearly shifted back to inflation.
On Friday, the April jobs report showed 115,000 positions created, significantly above the 65,000 anticipated by economists. This marks the first time in a year that the US economy has added jobs for two consecutive months. The report aligns with data released in recent weeks: the US economy is performing well, the job market remains robust and the Fed can now concentrate on the other side of its mandate (inflation).
In 2025, labor market concerns prompted the Fed to cut rates three times at the last three meetings of the year. This monetary easing was expected to continue into 2026, as the Fed anticipated a gradual retreat in inflation. The prevailing theory was that inflation, excluding tariffs, was nearing 2%. Since tariffs have a transitory effect on prices, their impact on inflation was expected to dissipate over time.
Consequently, a consensus had formed that the next move would be a cut, with the debate centered on timing. However, the question is no longer when rates will be lowered, but insttead whether they will need to be increased. The war in Iran has caused energy prices to soar, reigniting inflation. In March, inflation reached 3.3%, its highest level since March 2024.
At its last meeting, the Fed maintained a dovish bias in its statement, which came as somewhat of a surprise. Nevertheless, the decision was marked by four dissenting votes, three of which specifically concerned this issue.
With inflation having remained above the Fed's target for five years now, the war in Iran represents a new price shock that the Fed can hardly ignore. In principle, an energy shock is transitory, allowing central bankers to "look through" it (and thus take no action).
However, when crises occur in succession and inflation remains stubbornly high, such shocks can no longer be ignored. The risk is a de-anchoring of inflationary expectations as businesses and consumers become accustomed to a more inflationary environment.
This risk was highlighted by Christopher Waller in a mid-April speech entitled "one transitory shock after another." This stance was particularly notable given that Waller had been one of the most ardent supporters of rate cuts since the easing cycle began in 2024.
The bar still appears quite high for a Fed rate hike this year, in contrast to other major central banks that could take action as early as June. According to the CME FedWatch Tool, investors are pricing in a status quo throughout 2026.
Inflation will be the primary focus this week, with the release of the Consumer Price Index (CPI) on Tuesday and the Producer Price Index (PPI) on Wednesday in the United States. The consensus expects the CPI to hit 3.7%, which would be its highest level since September 2023.
