Fed on Hold as Middle East Conflict Redraws the Rate Cut Roadmap

The U.S. Federal Reserve kept its policy rate unchanged at the March 2026 FOMC meeting, maintaining the federal funds target range at 3.5% to 3.75%. The decision came amid a more complex macro backdrop, shaped by Middle East tensions, firmer inflation, and resilient domestic growth. It was largely unanimous, with Governor Miran the sole dissenter, favouring a 25 basis point rate cut.

Inflation Pressures Build; Easing Pushed Back

The Committee’s March projections (Exhibit 1) show a clear upward shift in the inflation outlook. The median PCE inflation forecast for 2026 was raised to 2.7%, from 2.4% in December—a 30 basis point increase driven largely by higher energy prices linked to geopolitical tensions. Core PCE was also revised higher to 2.7% for 2026, with inflation now expected to return to the 2% target only by 2028. The longer-run federal funds rate estimate was edged up to 3.1%, suggesting a subtle reassessment of the neutral rate.

Despite these upward revisions, the base case still points to one rate cut in 2026 and another in 2027, bringing the policy rate down to around 3.1%. As illustrated in Exhibit 2, the federal funds rate has been trending lower since its 2024 peak, though markets now anticipate a more gradual easing cycle. Interest rate futures currently price in roughly 15 basis points of cuts through end-2026, down from expectations of a full cut earlier in the week. Chair Powell reiterated that any move toward easing will remain firmly data-dependent, with sustained progress on inflation required before action is taken.

Growth Outlook Strengthens Despite Geopolitical Risks

In contrast to the inflation revisions, the FOMC upgraded its growth outlook. Real GDP for 2026 is now projected at a median of 2.4%, up slightly from 2.3% in December, with forecasts for 2027 and 2028 also revised higher. This reflects continued confidence in the durability of U.S. economic momentum. Capacity constraints across labour and capital remain a factor, with the unemployment rate expected to rise modestly from 4.4% in 2026 to 4.2% by 2028, broadly in line with earlier projections.

The combination of firmer growth and elevated inflation points to a mild stagflationary backdrop, although the Fed continues to view the current energy-driven inflation pressures as transitory.