During the final four months of 2025, the Fed lowered the federal funds rate (FFR) three times by a total of 75bps. The cuts were justified for two reasons: Inflation was approaching the Fed's 2.0% target, and the labor market was weakening. So the FFR was deemed to be too restrictive, i.e., above the "neutral" FFR. Under the Fed's dual mandate, the risk that unemployment would rise was increasing, while the risk that inflation would rise was falling.
Neither of these conditions holds today. Inflation has moved higher. Hiring has picked up, and the unemployment rate has remained low. Arguably, the current FFR is no longer restrictive, as the neutral rate has been boosted by robust AI-related capital spending and a drop in the personal saving rate as Baby Boomers retire.
The balance of risks suggests that the FOMC needs to pivot away from its easing bias at today's meeting. Here is an update on the current status of the Fed's dual mandate to maintain stable prices and full employment.
(1) Target practice. Headline and core CPI inflation rates have both exceeded the Fed's 2% target for five consecutive years. The former rose to 4.2% y/y in May, its highest since April 2023. The latter reached 2.9%, the loftiest since September 2025.
(2) Energy inflation. Most of the recent acceleration in inflation is attributable to the jump in energy prices caused by the Persian Gulf war. Gasoline surged 40.5% y/y in May's CPI, lifting overall energy inflation to 23.5%, its highest reading since August 2022 (chart). The US-Iran peace deal, set to be signed on Friday, should reopen the Strait of Hormuz. As a result, petroleum prices have fallen sharply in recent days.
