Where’s inflation?

The FOMC meets again this week with no less uncertainty, overall, than last month. True, the trade confrontation has given way to talks – even if their outcome remains unclear – but at the same time the exacerbation of tension in the Middle East puts in doubt what had been one of the very few tailwinds benefiting the world economy recently: the decline in oil prices. There are two parameters which we will closely monitor to assess the risk of a persistent oil shock: how Gulf states – and particularly Saudi Arabia – position themselves on oil supply, and the likelihood of a disruption in oil flows through the Strait of Hormuz. It is early days, but on balance the risk still seems containable.

Were it not for the exogenous shocks – tariffs and oil – it seems that the Fed has successfully concluded the post-pandemic policy cycle, to borrow from Christine Lagarde’s expression about the ECB two weeks ago. The May print for the US CPI was particularly encouraging. It is getting surprising that no tangible sign that the tariffs are starting to bite has emerged, as even core manufactured goods prices were tame, apparently disproving the Fed’s assessment of the first trade war of 2018-2019 of a rapid pass-through. However, a key difference between now and then is that the level of preparation of US stakeholders was much higher this time. Inventory building may delay the transmission.

While the re-affirmation of the Fed’s “wait and see attitude” is highly likely this week, the FOMC dot plot for 2026 and 2027 could reflect some divergence across members, with hawkish and dovish clusters appearing, divided over the risks of inflation persistence in the US. We explore in detail the recent speech by Christopher Waller, which very neatly makes the dovish case. Some of his arguments are seductive, but the ongoing crackdown on immigration weakens his point on the normalisation of US labour supply. Besides, his views matter more for the terminal rate – whether the Fed could go all the way into accommodation – than for the next few months of US monetary policy.