Where does the Fed go from here?

At its April meeting, Jerome Powell’s last as Federal Reserve Chair, the Federal Open Market Committee (FOMC) left the target range for the federal funds rate unchanged at 3.50%-3.75% for a third consecutive meeting, as widely expected.

The decision was notable only for the degree of dissent. For the first time since 1992, four members dissented: one opposing the decision to hold rates steady, and three registering (soft) dissents against the inclusion of an easing bias in the post-meeting statement.

The key takeaway from today’s press conference is that the Fed is deeply divided over its policy outlook. While the tone has shifted modestly in a more hawkish direction, this does not signal renewed rate hikes. Rather, it points to a prolonged period of steady rates.

Economic backdrop

The meeting took place amid an unusually uncertain backdrop, clouded by ongoing developments in the Middle East. Powell stressed that with the scope, duration, and trajectory of the conflict still unclear, the policy environment is particularly difficult to assess. Even so, he provided some colour on the underlying state of the economy.

Growth: Economic activity continues to expand at a “solid” pace. Resilience remains evident, underpinned by steady consumer spending and sustained demand for data centers. Powell argued that the U.S. economy is better positioned today, relative both to the 1970s and to regions such as Europe, to absorb an oil‑price shock.

Labor market: Job growth has slowed, but this reflects a decline in labor-force growth, driven in large part by lower immigration. At 4.3%, the unemployment rate remains low by historical standards.

Inflation: Near‑term inflation expectations have edged higher, likely reflecting the surge in oil prices, but longer‑term expectations remain “consistent with our 2% inflation goal.” Powell was clear, however, that the Committee will need confidence that tariff‑related price pressures have faded and that higher energy prices are not feeding through into broader inflation expectations before resuming rate cuts. It is simply “too early to judge,” particularly given that the energy shock “hasn’t even peaked yet.”

Policy language and easing bias

Changes to the statement were modest but meaningful. The FOMC chose to retain its easing bias, despite internal disagreement. When pressed, Powell argued that the uncertainty surrounding the oil price shock made this an inopportune moment to adjust the language.

That said, one could argue that such uncertainty called for a more explicit acknowledgment of two‑sided risks rather than a slightly dovish tilt. Overall, Powell conveyed a sense that policy is likely to remain on hold for an extended period, even as the Committee continues to believe that some further easing will ultimately be appropriate.

The handover

Powell’s term as Chair concludes on May 15, with Kevin Warsh all but certain to assume the role at the next meeting. Powell also announced that he will remain on the Board of Governors, though the timing of his departure has yet to be determined. While he stressed that he does not intend to overshadow Warsh or exert outsized influence over policy, his decision limits President Trump’s ability to reshape the Committee with additional appointments more aligned with his preferences. Markets are now awaiting a potential response from President Trump.

Outlook

The policy outlook is exceptionally complex. With Brent oil prices near $120 per barrel and inflation having overshot the target for five years, the Fed cannot ignore the risk that inflation expectations may become de‑anchored. At the same time, they must stay alert to signs of economic and labor market softening as households and businesses contend with mounting affordability pressures.

Compounding this uncertainty is the impending leadership transition. Markets are already contemplating the possibility of a regime shift under Warsh, potentially involving a smaller balance sheet, changes to inflation measurement, a greater focus on AI‑driven productivity, and a different communication style. Together, these forces may make the future path of policy especially hard to decipher.

Our base case is that the Fed’s easing bias remains in place, only just, but that the data will need to turn decisively more dovish for further cuts to materialise. We expect the next rate cut to be delayed until September, if not December, with a second 25bps cut pushed into early 2027. This is more dovish than current market pricing, which increasingly assigns a non‑trivial probability to a rate hike in 2027.

Principal Asset Management