Fed keeps rates unchanged and drops dovish tilt

Kevin Warsh's first meeting as Fed chair ended on Wednesday. The committee decided to keep rates unchanged and removed key language suggesting a tilt toward cuts, while sharply shortening the policy statement.

The Federal Open Market Committee (FOMC) voted unanimously to keep the benchmark overnight borrowing rate unchanged in the 3.5% to 3.75% range. The federal funds rate has stayed there since the central bank cut rates by 0.75 percentage point in the second half of 2025.

Although markets were curious and speculating about Warsh's leadership, the meeting followed this year's established pattern on the rate decision, but differed in other ways.

Fed officials withdrew this year's rate-cut expectation through the closely watched "dot plot" and signaled that a hike is possible, though not certain. However, one member's forecast was missing from the dot plot, and market watchers suspected Warsh may not have submitted his projection.

A note attached to the forecast materials showed that 18 of the 19 participants submitted rate and economic projections. Because the dot plot is an anonymous aggregation of expectations, it is impossible to know whether the missing forecast was indeed Warsh's. But ahead of the meeting, market watchers widely expected Warsh not to take part in the Summary of Economic Projections (SEP). Some suspected he might even try to scrap the mechanism altogether. There was also a missing dot in the 2028 forecast.

Warsh has criticized the dot plot as a forecasting tool, along with other forms of forward guidance used by the committee, including the Summary of Economic Projections' forecasts for unemployment, inflation and GDP.

Beyond the rate decision largely expected by markets, the FOMC's post-meeting statement not only removed wording that had suggested an easing bias, but also cut the rest of the statement sharply.

This week's statement was only 130 words, compared with 341 after the April 29 meeting. It offered only a brief summary of economic conditions before pledging to control inflation.

The statement said: "Despite some degree of uncertainty, partly due to the conflict in the Middle East, economic activity continues to expand at a solid pace. Productivity growth and capital investment have been strong. Employment growth has kept pace with labor-force growth, and the unemployment rate has changed little."

The committee added: "Inflation remains above the Committee's 2% objective, in part because supply shocks have pushed up prices in some areas, including energy. The Committee will remain committed to achieving price stability."

The statement also said the Fed would maintain its policy of keeping "ample reserves" in the banking system, suggesting there is no immediate plan to shrink bond holdings in the central bank's $6.7 trillion balance sheet, even though Warsh has advocated such a move.

At the April meeting, reserve bank presidents had opposed the so-called forward-guidance language because they wanted to keep both options open for future hikes or cuts, which led to three dissenting votes. This statement passed unanimously.

With the rate outlook uncertain, officials also adjusted guidance on future policy. The anonymous dot plot of participants' rate expectations erased the prior expectation of one cut this year and pushed any cuts out to 2027 and 2028 as policymakers assess how persistent the inflation surge driven by the Iran war may be.

The dot plot showed the median forecast for the fed funds rate at year-end was 3.8%, about 0.16 percentage point above the current level, indicating a hike is fully on the table. Officials continued to forecast a long-run fed funds rate of 3.1%.

Officials revised their view of the economy, raising the 2026 headline inflation forecast to 3.6% and the core inflation forecast, excluding food and energy, to 3.3%. In March, the committee had forecast 2.7% for both. It also slightly lowered GDP growth expectations to 2.2%, down 0.2 percentage point from March, and cut the unemployment forecast to 4.3%, down 0.1 point.

The inflation spike has put policymakers in a bind, because traditional policy training tells them to look through short-term supply shocks such as war-related energy price surges.

Recent inflation readings have hit multi-year highs, with the May CPI showing annual inflation of 4.2%, though the core measure excluding food and energy was lower at 2.9%. Over the past five years, inflation has remained above the Fed's 2% target.

Although Warsh has made few public comments since his confirmation hearing before being sworn in as chair on May 22, he has argued that policymakers should normally look through supply-shock inflation when setting policy. He has also insisted that AI will ultimately have a disinflationary effect on the economy because higher productivity will help lower the cost of goods and services.

Still, an unexpectedly strong labor market has complicated the case for rate cuts. Nonfarm payrolls again beat expectations in May, rising by 172,000, while the unemployment rate, the Fed's most closely watched gauge, has stayed at 4.3% over the past year.

Market pricing matches the FOMC's outlook. According to CME's FedWatch tool, the market expects no rate cuts in 2026 and is pricing in a 25-basis-point hike by year-end.