FOMC Watch - July on hold, September on the table
We expect the FOMC to leave rates unchanged next Wednesday. June CPI surprised significantly to the downside and, even if June core PCE comes in somewhat firmer (indeed, we expect 0.2% m/m), the recent inflation data should provide policymakers with sufficient confidence to wait for additional evidence on both inflation and labour-market trends before the September meeting.
That said, the renewed escalation around the Strait of Hormuz and the sharp rise in oil prices over the past week have increased pressure on the Fed. The latest FOMC minutes suggest officials broadly see two possible paths: (i) inflation improves 'soon', allowing rates to remain on hold; or (ii) inflation proves stickier, driven by both energy prices and AI-related demand pressures, requiring ‘some’ further policy firming. Recent Fed communication has largely reflected individual members' preference for one of these narratives. While incoming, backward-looking data has favoured the first scenario, developments in Iran, which led to rapidly rising oil prices, have raised the likelihood of the second. In addition to the energy shock, a new round of tariffs is about to take effect. These tariffs are being implemented under Section 301 and, in our view, rest on far firmer legal foundations than the measures they replace, namely the IEEPA tariffs struck down by the Supreme Court and the expiring Section 122 tariffs. On a trade-weighted basis, the overall tariff burden is broadly unchanged from the Section 122 package. As a result, we do not expect a meaningful new inflation impulse. While certain details in the new package may create price pressures for specific goods from certain trading partners, the overall package closely resembles the existing tariff regime. Most of the associated price effects have already been passed through, limiting the scope for an additional inflationary impact. Our base case remains the first narrative, in which the policy rate stays on hold for the remainder of the year. However, we view September as a live meeting at which a rate hike remains a realistic possibility. For rates to stay on hold, tensions around Iran will need to ease materially in weeks rather than months.