The stock market rally should get a boost from the announcement of an apparent movement toward a 60-day cease fire in the Iran war and opening up of the Strait of Hormuz. It raises the possibility of an unwinding of the run-up in oil prices, although the extent and speed of a price drop are uncertain. The announcement comes on top of very strong corporate earnings (with the S&P 500 earnings up 27% y/y in Q126). And, the macroeconomic background remains positive. The latter continues to show solid growth, little change in the labor market, and high inflation. However, much of the high inflation can be attributed to relative price changes resulting from tariffs and higher oil prices -- the latter which now look likely to be temporary.
The effects of a US/Iran agreement could impact Fed monetary policy. A significant drop in oil and other commodity prices, if they in fact happen, would unwind the run-up in inflation in the past few months from their war-related surge. As a result, Fed officials may hold back from altering the FOMC Statement to eliminate an easing bias at the next meeting on June 16-17, in contrast to the sentiment expressed at the April 28-29 meeting (see below). The new Fed Chair Kevin Warsh, who is likely to be more open to easing than Powell, could argue to keep the Statement as is now that oil prices may be moving down (or already have by the time of the Meeting). Maintaining an easing bias in the Statement would be a positive for the stock market.
The Minutes of the April 28-29 FOMC Meeting did not contain any surprises. The Fed staff raised its economic forecast a bit, looking for growth to exceed its longer-run 1.8-2.0% potential pace over the next few years. It cited "favorable financial conditions, continued gains in AI-related capital spending, and a reversal of some of the factors that were expected to weigh on activity this year, including weak foreign growth and uncertainty about the outlook." The Unemployment Rate was expected to remain close to current levels into 2027 before dipping in 2028. Inflation was expected to slow in the second half of 2026 as the one-off effects of tariffs and the Iran war wear off. It is seen slowing to close to 2.0% by the end of the year. There were downside risks to the real-side forecasts and upside risks to the inflation forecast. A drop in energy prices should reinforce the thrust of this outlook.
Most participants' views appear to be similar to the staff's forecast. Regarding inflation, they noted that measures of longer-term inflation expectations remain stable. However, "the vast majority of
participants noted an increased risk that inflation would take longer to return to the Committee’s
2 percent objective than they had previously expected." In contrast, while "participants generally expected labor market conditions to remain stable in the near term ... most judged the risks to the employment side of the Committee's dual mandate were tilted to the downside."
The combination of contained longer-term inflation expectations and balanced risks calls for steady monetary policy, which the Committee members agreed is the case. However, there was concern that higher rates in the future might be necessary. "A majority of participants highlighted, that some policy firming would likely become appropriate if inflation were to continue to run persistently above 2 percent. To address this possibility, many participants indicated that they would have preferred removing the language from the post-meeting statement that suggested an easing bias regarding the likely direction of the Committee’s future interest rate decisions."
The latest update of the University of Michigan Consumer Sentiment Survey's measure of longer-run inflation expectations was likely a concern to these Fed officials. The 5-Year Inflation Expectations jumped to 3.9% in May, well above the 3.2-3.4% recent range. However, the May level is still within the 3.2-4.4% range seen since March 2025 and now, with a potential US/Iran agreement in sight, could be discounted as temporary.
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