Fed pauses rates again as Middle East tensions risk hotter inflation

The Federal Reserve on Wednesday left its benchmark interest rate unchanged, maintaining a target range of 3.5% to 3.75% for a fifth consecutive meeting.

Heading into the meeting, most monetary policy watchers had expected the Fed to stand pat after inflation cooled in June. Still, a minority (about 30%) had penciled in a hike, a mix described as unusual.

The central bank made its decision amid cooling inflation numbers and a still-resilient job market. The Consumer Price Index (CPI) for June fell 0.4% on a seasonally adjusted basis, following a 0.5% rise in May, driven mainly by a 9.7% drop in gas prices when a now-defunct peace deal was signed by the U.S. and Iran.

Meanwhile, the U.S. added 57,000 jobs in June, at a pace below expectations over the past few months. With Middle East tensions still ongoing, some experts believe recent oil price increases have yet to be reflected in inflation numbers.

“When the war started, a lot of producers tried to bear some of the expense, and now it’s being passed on to the consumers — it’s much harder once you raise prices to pull them back down,” said Melissa Cohn, regional vice president at William Raveis Mortgage. 

The Federal Open Market Committee (FOMC) approved the move in a 9-3 vote. Cleveland Fed President Beth M. Hammack, Minneapolis Fed President Neel Kashkari and Dallas Fed President Lorie K. Logan dissented, voting instead for a 25-basis-point increase.

“The Committee decided to maintain the target range for the federal funds rate at 3-1/2 to 3-3/4 percent, in support of the Federal Reserve’s dual mandate. The Committee is continuing its policy of maintaining ample reserves in the banking system,” the FOMC said in a statement released Wednesday.

“Economic activity is expanding at a solid pace despite elevated uncertainty that owes, in part, to the conflict in the Middle East. Productivity growth and capital investment are strong. Job gains have kept pace with the workforce, and the unemployment rate has changed little. Inflation remains elevated relative to the Committee’s 2 percent goal, in part reflecting supply shocks that have driven price increases in certain sectors, including energy. The Committee will deliver price stability.

Effects of reduced forward guidance

Fed Chair Kevin Warsh characterized Wednesday’s decision to hold rates steady not as a pause, but rather as a period of “watchful thinking, not watchful waiting.” He said that markets have tightened as nominal and real Treasury yields have risen materially, with some of the increases since the prior FOMC meeting among the most significant in the past two decades.

“Prices reacted in real time to incoming information, and the reduction in forward guidance may have been a factor. Market participants are learning to play the ball, not the referee.”

Addressing June’s inflation numbers, Warsh said that “five-plus years of inflation above target cannot be cured in nine weeks, or by a single month of modest price decreases.”

He added that the historic problem with data dependence is both “the data and the dependence,” adding that officials are not using any single piece of data as an excuse or validation. Instead, the committee remains focused on broader data trends.

“We got some encouraging inflation data, and we’ll be watching inflation data over the period ahead,” Warsh said. “But I also don’t want you to leave with the misimpression that we’re breathlessly waiting.”

Regarding the Fed’s communication strategy, he noted that the policy statement intentionally conveys just the facts and steers clear of forecasting — a prudent choice given current economic uncertainty.

“Uncertainty, however, does not mean a lack of clarity,” Warsh said. “For some households, businesses and market professionals, five years of high inflation have left a mistaken impression that’s hard to shake — that the Fed’s implicit inflation target was somehow above 2%. Let me reiterate: There is no soft inflation target. There is no soft implicit target — not on this committee’s watch.”

A vigilant Fed

According to Cohn at William Raveis Mortgage, 2026 was supposed to be the year of lower interest rates, but instead, “we’re back to rates that are as high as they were a year ago.” She expects the Fed to be conservative and vigilant, and “certainly not exude any sort of true dovish terms.”

“It’s healthier for markets for the Fed to raise rates and put the fight against inflation at the top of the agenda, and not sit back and wait, because we’ve been at war now for five months. It’s going to take months and months to undo that damage.”

For First American senior economist Sam Williamson, the “bar for raising rates has fallen — and could fall further if higher energy costs begin spreading into broader prices.” 

“Escalating tensions in the Middle East have renewed pressure on oil and gasoline prices, making a rate hike more plausible than it appeared just a month ago,” Williamson said in a statement. “Meanwhile, the labor market remains resilient, with initial jobless claims near historic lows.” 

As of Wednesday afternoon, about 59% of monetary policy watchers anticipated a hike of 25 bps in September, while only 1% expected a 50-bps increase, according to the CME Group’s FedWatch tool.

“History says the Fed does not surprise hawkish with hikes. According to Fed Funds futures data since 1994, the Fed has never hiked with less than 60% priced,” analysts at Bank of America Securities wrote on Tuesday.

The BofA analysts said that a hike sooner rather than later differentiates Warsh from his predecessor Jerome Powell. It would allow him to claim credit for any disinflation down the line, even if it’s caused by a decline in energy prices due to military deescalation with Iran or tariffs rolling off annualized inflation.

Mortgage market impact

For the mortgage industry, Cohn said that the bond market’s interpretation of the Fed’s statements and actions is more important. “A hawkish Fed is just what the doctor ordered right now; to be dovish and to say that runaway inflation is OK is just not the message that the markets want,” she said.

Williamson added that if investors understand how policymakers are likely to respond to incoming inflation data, markets will be better positioned to interpret new information as it arrives. 

“Should price pressures ease, Treasury yields and mortgage rates could decline as confidence grows that policy easing is becoming more likely,” he said. “That would improve affordability, all else held equal, and could provide the catalyst the housing recovery still lacks, bringing more buyers and sellers back into the market.”

Editor’s note: This story was updated with post-meeting comments from Fed Chair Kevin Warsh.