Inflation concerns reshape the policy outlook
The US dollar advanced against every major currency on Wednesday after the Federal Reserve opened the door to higher borrowing costs later in 2026.
Although policymakers unanimously maintained the federal funds rate between 3.50% and 3.75%, their quarterly projections revealed a significant shift. Nine officials now expect at least one increase before the end of the year, contrasting with earlier forecasts for a reduction.
Warsh removes forward guidance
The revised policy statement eliminated previous references to possible rate cuts and offered no indication about the direction of the next move. It simply announced the decision and reiterated the Fed’s intention to maintain “ample reserves in the banking system.”
The streamlined communication provided an early indication of Chairman Kevin Warsh’s approach. Appointed by President Donald Trump, Warsh succeeded Jerome Powell, who remains a voting member of the Federal Open Market Committee in his role as governor.
“This Fed decision was short, but not sweet,” said Karl Schamotta, chief market strategist at Corpay in Toronto.
“Kevin Warsh moved swiftly to put his stamp on the central bank’s communication strategy by executing a dramatic revision to the official statement, wiping out anything resembling forward guidance and editing out the bulk of the contextual information typically parsed most closely in financial markets.”
Inflation forecast jumps to 3.6%
Federal Reserve officials raised their inflation projection for the end of 2026 from 2.7% to 3.6%. The revision suggests that policymakers remain concerned about price pressures despite the provisional agreement intended to end the war between the United States and Iran.
“The committee turned sharply hawkish, with the median participant yanking inflation projections much higher – suggesting that officials don’t expect this weekend’s U.S.-Iran deal to result in a serious easing in price pressures – and penciling in at least one hike this year, marking a stark contrast with the cut previously expected,” Schamotta said.
Markets price in a September increase
Short-term interest-rate futures indicated that a Fed increase by September had become more likely than keeping borrowing costs unchanged. Treasury yields rose, equities declined and the dollar index gained 0.5% to 100.01, its highest level in almost a week.
The euro fell 0.5% to $1.1549. Stronger-than-expected US retail sales for May generated little additional movement because investors remained focused on the central bank’s more restrictive stance.
“Markets are taking it on the chin, with yields moving up in line with rate expectations, the dollar advancing against all of its major rivals, and equity markets tumbling,” Schamotta said.
Lower oil prices may provide delayed relief
The interim US-Iran agreement has pushed crude prices lower, potentially reducing inflationary pressure over the coming months. However, any benefit for household energy bills could take time to emerge, limiting its immediate influence on monetary policy.
Attention turns to the Bank of England
The Bank of England is expected to leave its policy unchanged on Thursday, placing greater importance on the language used by officials. UK inflation unexpectedly remained at 2.8% in May, matching April’s 13-month low.
Financial markets anticipate one British rate increase before the end of 2026. Sterling declined 0.5% following the Fed announcement, trading at $1.3361.
Yen remains close to intervention territory
The Japanese yen surrendered most of its earlier gains and was trading 0.05% higher at 160.385 per dollar. Its persistent weakness continued to fuel speculation that Japanese authorities could intervene in the currency market.
The Bank of Japan raised interest rates on Tuesday to their highest level in 31 years. While officials indicated that further tightening remains possible as they confront energy-driven inflation, they provided few details about when another increase could occur.
Swedish crown weakens after Riksbank decision
Sweden’s Riksbank also kept its benchmark rate unchanged. The central bank warned that the Iran war had intensified inflationary risks and increased the possibility of a future hike, even as underlying price growth remained moderate and economic activity stayed slightly below normal.
The Swedish crown lost 0.8% against the US currency, reaching 9.4382 per dollar.
