Fed looks to stay on the sidelines

The Federal Reserve kept policy rates unchanged overnight, holding the Fed Funds rate at 4.5% on the upper bound. In its statement accompanying the FOMC decision the Fed said that “economic activity has continued to expand at a solid pace” while “uncertainty about the economic outlook has diminished but remains elevated.” The Central Bank of the UAE kept its Base Rate unchanged at 4.4%.

In its summary of economic projections the Fed cut its expectations for growth to 1.4% for 2025, down from 1.7% published at the March FOMC. Growth expectations for 2026 were also revised marginally lower. More notable was a shift higher in inflation projections to 3% for PCE inflation, meaningfully away from target levels of 2% and up from 2.1% in April. The dots plot, though, was maintained at 50bps of easing by the end of 2025 though the outlook for 2026 was changed to just 25bps of cuts.

The Fed’s freedom of action for policy this year is hamstrung by substantial policy uncertainty. The tariffs introduced by the Trump administration across multiple geographies have yet to have a noticeable impact on inflation or employment in the US yet there is no clarity on whether the “Liberation Day” tariffs announced on April 2 will be reimposed when their 90-day suspension ends in early July or if they will be extended again. Fed Chair Jerome Powell said explicitly that the Fed knows the impact of tariffs on consumers is coming but that they “just want to wait and see a little bit of that before we make judgments prematurely.” Whether the sharp rise in oil prices in the last week caused by market anxiety over the war between Israel and Iran is sustained will also be an exogenous risk to the inflation outlook.

Inflation in the UK was steady at 3.4% year/year in May, modestly ahead of market expectations. Core inflation was slower at 3.5% y/y in May from 3.8% a month earlier. Transport was a major drag on the inflation index last month while household and miscellaneous goods and food prices were higher. The Bank of England holds an MPC meeting today and is likely to keep rates unchanged before resuming modest cuts later this year.

Inflation in Oman rose by 0.6% y/y in May according to the last CPI index. Housing and utilities costs were flat in May while goods and transport prices were higher than the same period last year. Food prices were 0.8% lower. The May CPI represents a notable cooling in inflation from a month earlier when prices were nearly 1% higher y/y.

Today’s Economic Data and Events

15:00 UK Bank of England bank rate: forecast 4.25%

15:00 TU One-week repo rate: forecast 46%

Fixed Income

US Treasuries faded an early rally in response to the Fed as comments from Fed chair Jerome Powell during his press conference suggested the Fed would need to stay on the guidelines for a prolonged period. Yields on the 2yr UST ultimately closed lower by 1bps to 3.9414% while the 10yr UST yield closed essentially unchanged. Markets are now pricing in about 48bps of easing by the end of the year.

FX

Currency markets broadly turned lower against the US dollar following the Fed although stronger risk-off undercurrents related to the was between Israel and Iran are also weighing on markets. EURUSD closed unchanged overnight at 1.1480 while GBPUSD touched lower at 1.3422. USDJPY moved in favour of the yen with a drop of 0.1% at 145.13.

Equities

Equity markets faded initial gains on the day though the sell offs were relatively modest. The Dow Jones fell by 0.1% while the S&P was little changed and the NASDAQ managed a gain of 0.1%. European markets fell more heavily with a 0.4% decline in the Euro Stoxx index.

In local markets the DFM fell by 1.2% overnight while the ADX 15 sank by 0.6%. The Tadawul was lower by 1.1%.

Commodities

Oil closed marginally higher overnight with market focus squarely on the Middle East. A sharp mid-day sell off related to reports that Iranian officials had gone to Oman was unwound over the rest of the trading session with Brent closing the day up 0.3% at USD 76.70/b and WTI at USD 75.14/b.

Commercial crude inventories in the US drew by 11.5m bbl last week, their largest draw in the last year. There were moderate builds across the barrel but the overall draw in petroleum was still large at 6.6m bbl. Oil production was steady at 13.4m b/d.