In March, the Federal Reserve kept the benchmark rate unchanged at 3.5%-3.75%, an outcome widely expected as policymakers faced an unusually complex macroeconomic environment. The modest upward revisions to short-term inflation projections suggest that Fed officials view the recent energy supply shock as largely transitory rather than a trigger for persistent inflationary pressures.
Overall, the Fed has shown continued caution regarding the timing of future rate cuts. The median path still indicates monetary easing over the long term, but officials seem intent on waiting for greater clarity on the persistence of recent oil price shocks. This caution reflects uncertainty surrounding the conflict in Iran and risks related to global energy supply, as well as doubts about whether higher oil prices will remain temporary or have a more lasting impact on U.S. wages and inflation expectations.
In light of risks on both sides of the dual mandate, along with updated projections and Fed communications, we continue to expect the Fed to keep rates unchanged for much of 2026 before resuming the easing cycle toward a neutral interest rate just above 3%.
THE ENERGY SHOCK IS A BALANCE OF RISKS
The military conflict in the Middle East has increased the risk of a significant global energy supply shock.
Although the Fed tends to look past energy price fluctuations when assessing underlying inflation pressures, the current context is more complex given the economy’s recent experience with above-target inflation. As a result, some officials appear more sensitive to the risk that persistent energy price increases could unanchor inflation expectations or influence wage-setting mechanisms. In his press conference, Fed Chair Jerome Powell also noted that the U.S. shift toward a net energy exporter role could mitigate the negative impact on economic activity from higher oil prices, as sustained increases might stimulate further investment in the domestic energy sector.
At the same time, the U.S. economy has faced this crisis with weaker underlying real income growth and a labor market that appeared less robust than overall GDP data suggested, as recent employment and total hours worked data indicated a stagnating labor market. In our view, these labor market vulnerabilities represent a more concrete risk in light of the short-term activity boost supported by tax refunds. Some Fed officials seem to share this view, reinforcing the idea of a cautious approach rather than preemptive tightening.
This perspective is further confirmed by the composition of recent growth. U.S. GDP has been disproportionately driven by productivity gains rather than labor input or underlying demand. With tariff effects fading and strong productivity helping to contain unit labor costs, we believe the odds of new tightening are low, an opinion shared by Powell in his press conference.
UPDATED PROJECTIONS SHOW CAUTION AND CONVERGENCE
The updated version of the Fed’s «Summary of Economic Projections» provides further insight into how officials assess current risks. Energy price increases are expected to raise headline inflation in the short term and may slightly push up core inflation, but projections indicate limited impact on GDP growth or labor market conditions.
Productivity-driven growth remains a central element of the economic outlook. High productivity helps explain why U.S. growth has maintained resilience despite weakening real income growth and slowing labor demand; from an inflation perspective, productivity tends to offset cost pressures, supporting disinflation over time even when headline inflation is temporarily pushed up by energy prices.
Although changes to projections have not significantly altered median interest rate outlooks, policymakers’ forecasts for 2026 (the so-called «dot plot») have clustered more tightly around the median value. Despite this apparent convergence, Powell emphasized the unusually low confidence in forecasts given uncertainty about both the magnitude and persistence of the energy shock. While productivity was cited as a driver of sustained growth over the projection horizon, officials see only a partial shift toward neutral rates, with the long-term benchmark revised upward by just 10 basis points.
POWELL CALLED FOR PATIENCE IN A CLIMATE OF UNCERTAINTY
During the press conference, Powell avoided endorsing a more dovish stance that the Fed should simply «ignore» the energy shock given rising uncertainty. At the same time, he rejected the idea that new monetary tightening is seriously under consideration, emphasizing the Fed’s preference for patience.
Powell also addressed leadership transition issues. His likely successor, Kevin Warsh, could face delays in the confirmation process; if necessary, Powell would remain in office on an interim basis until the process concludes. Powell added that he intends to stay at the Fed until any Department of Justice investigation is resolved. Although Powell’s term as chair expires in May, his term as Fed governor runs through January 2028, and he stated he has not yet decided whether to remain until the end of that term.
CAUTION AND STABILITY CONTINUE TO CHARACTERIZE FED POLICY
Looking ahead, policymakers continue to forecast a gradual decline in interest rates, but their conviction remains modest due to the energy shock. Powell noted that economic growth remains solid and labor market weakness is contained, reflecting a slowdown in both supply and demand. Although core inflation remains above target, he attributed much of its persistence to tariff effects rather than overheating demand.
As tariff effects fade—and with productivity-driven growth continuing to contain unit labor costs—core inflation should continue to approach the target, even as rising oil prices temporarily push headline inflation higher. Combined with rising downside risks to the labor market, this context favors a gradual and cautious easing cycle toward the neutral rate estimated by the Fed, just above 3%.
