The Federal Reserve's "fault line"

1. Meeting Background: The U.S. Economy Hovering in Stagflation Shadows

The Federal Open Market Committee meeting held from April 29 to 30, 2026, is destined to leave a significant mark in Fed history. Not only is this the last policy meeting under Chair Jerome Powell’s tenure, but it also represents a fierce ideological clash amid complex geopolitical tensions and economic data. Since the outbreak of the U.S.-Iran conflict in late February, global capital markets have undergone intense stress testing, with disruptions in the Strait of Hormuz directly causing international energy prices to surge, with Brent crude reaching multi-year highs. Meanwhile, inflationary pressures in the U.S. have become more severe: in March, the Personal Consumption Expenditures Price Index rose 3.5% year-over-year, and core PCE increased 3.2% YoY, well above the 2% long-term target. At the same time, the labor market presents a contradictory picture—official unemployment remains low at 4.3%, but net new job creation is sluggish, even approaching zero growth, indicating a weakening absorption capacity. The Beige Book also notes that Middle East conflicts have become a source of “high uncertainty” for business decisions, with most firms adopting a wait-and-see stance. Against this backdrop of looming stagflation risks, market focus has shifted from “whether to cut rates this year” to “whether the Fed still has room to hike.”

2. Policy Decision: The Largest Rift in 34 Years Beneath a Calm Surface

2.1 Keeping rates unchanged aligns with expectations

As widely anticipated, the FOMC decided to keep the federal funds rate target range at 3.5% to 3.75%. This marks the third consecutive pause since the January meeting. The policy statement acknowledged that “economic activity has been expanding at a solid pace,” but also explicitly stated that “inflation remains elevated,” emphasizing that the evolving Middle East situation has heightened economic uncertainty. Powell, in his post-meeting press conference, said that the current monetary policy stance is appropriate, with interest rates “very close to neutral,” which he defines as a range of 3% to 4%.

2.2 Rare Four Votes Against and the Rise of Hawkishness

While the rate decision itself was unsurprising, the voting results shocked markets. The vote was 8-4, with four dissenting votes—the largest internal disagreement since October 1992. Typically, market attention centers on Fed Governor Stephen Miran’s dovish dissent—he usually votes for a 25 basis point cut. However, the real storm was among the three hawkish dissenters.

Cleveland Fed President Beth M. Hammack, Minneapolis Fed President Neel Kashkari, and Dallas Fed President Lorie K. Logan, although agreeing to hold rates steady, strongly opposed the wording of the policy statement’s “accommodation bias.” Their concern was not the rate itself but the language. The current statement retains a key guidance phrase: “when considering further adjustments to the target range for the federal funds rate” . In Fed parlance, such wording typically hints at a future rate cut.

These three hawks believe that, given high energy prices and persistent inflation, the statement should not pre-commit to rate cuts. They advocate revising the language to reflect “two-sided risks”—meaning the next move could be either a rate hike, a cut, or no change. They argue that the current wording is seriously lagging behind reality and could mislead markets into underestimating the likelihood of a rate hike. This event marks a significant shift in the internal power balance of the Fed: while “holding rates steady” has majority support, hawks have sent a very strong signal regarding the potential for future tightening.

3. Powell’s Farewell Performance: Remaining as a Board Member and Defending Independence

3.1 Breaking the Tradition of Reappointment

This is not only a policy debate but also a prelude to leadership transition. Powell concluded his chairmanship with a highly personal and strongly worded press conference. He confirmed that after his term ends on May 15, he will not leave the Fed but will continue serving as a Board member. This breaks decades of precedent. Historically, departing chairs have resigned from the Board to clear the way for successors—Yellen and Bernanke did so. Powell’s decision to remain as a director until January 2028 means he will continue to have voting rights on the FOMC and hold a seat on the Board.

3.2 Fog of Investigation and Political Red Lines

Powell straightforwardly explained his reasons for staying on. He attributed it to “unprecedented legal attacks” launched by the U.S. government over the past three months. The background involves the U.S. Department of Justice’s criminal investigations into the Fed and Powell personally, mainly concerning cost overruns in the Fed’s headquarters renovation project. Although, just days before the meeting, the U.S. Attorney for D.C. announced the investigation had been terminated, Powell remains deeply concerned.

He clearly distinguishes between “political verbal attacks” and “legal actions.” He admits that public criticism from the President does not bother him, but the use of judicial power to investigate the Fed is a “red line that cannot be crossed.” He states, “I had planned to retire, but what happened over the past three months left me no choice but to stay until this investigation is truly and thoroughly over, with transparency and resolution.” He describes these legal actions as “unprecedented” in the Fed’s 113-year history, threatening the independence of the central bank.

3.3 The Shadow Chairman Dilemma

Powell’s reappointment has sparked market concerns about him becoming a “shadow chairman,” potentially sidelining successor Kevin Warsh. Powell offered reassuring comments: “I will never play the role of a ‘shadow chairman’… I plan to stay low-profile as a director and work hard to support the Chairman and his goals.” He emphasizes that the Fed always has only one Chairman, and once Warsh is sworn in, he will be the true Chairman. Nonetheless, his continued presence prevents President Trump from immediately appointing new directors to shift the Fed’s political landscape, which some analysts interpret as a form of institutional check.

4. The Stagflation Paradox: Powell’s Views on Energy Shocks’ Dual Nature

4.1 “Textbook” Cautious Wait-and-See Logic

In assessing monetary policy amid rising oil prices and inflationary pressures, Powell demonstrated a calm and cautious approach. He systematically explained why the Fed is not rushing to hike or cut rates—highlighting the dual constraints under stagflation risks.

Regarding inflation: Powell acknowledged that recent increases are mainly driven by energy prices due to Middle East conflicts and previous tariffs. He noted that tariffs typically cause one-time price level increases that dissipate over time, but the persistence of energy shocks remains uncertain. Currently, short-term inflation expectations have risen due to oil prices, but long-term inflation expectations remain anchored at 2%.

Regarding growth: This is the most speculative part of Powell’s discussion. He did not focus solely on oil prices pushing up CPI but pointed to the “negative wealth effect” or “income erosion effect” of rising oil prices. He explained: “If people have to pay higher gasoline prices, they will have less money for other spending. This will have a negative impact on growth.”

Powell painted a scenario: when oil prices reach a critical point (say $120, $130, or $140), market logic will reverse. Although initially high oil prices may boost rate hike expectations, once the squeeze on consumers’ disposable income causes significant economic slowdown, markets will start pricing in “recessionary rate cuts.” In other words, worsening growth factors will eventually outweigh inflation concerns, forcing the Fed to cut rates to rescue the economy. This is the most challenging dilemma for the Fed when facing supply shocks—unable to simply tighten monetary policy to address supply shortages while also preventing excessive tightening that kills demand.

4.2 Data-Dependent Final Chapter

Powell admits that the current policy stance is well-positioned to handle various scenarios, giving the Fed room to wait until energy conflicts and tariff impacts subside before making decisions. He states that before considering rate cuts, the Fed needs to see two signals: first, that tariff-induced price increases have receded; second, that the energy shock has “peaked.” He does not entirely rule out rate hikes but emphasizes that the threshold for raising rates remains high.

5. Dual Nature of Economic Data: Employment Concerns and Consumer Resilience

5.1 Labor Market Divergence

Despite the focus on inflation, subtle changes in the labor market underpin Powell’s “wait-and-see” stance. Data released before the meeting show that in April, non-farm payrolls increased by 175k, which is not extremely low but clearly below the trend of the past 12 months. The unemployment rate remains stable, but this masks a fact: declining labor force participation (partly due to reduced immigration) offsets the slowdown in job growth.

More notably, Powell admits that “net new hiring is approaching zero growth.” This indicates that, although firms are not mass layoffs (low unemployment), they are also halting large-scale hiring. The labor market is transitioning from “overheated” to “normal” or even “cooling.” In this environment, the Fed will be extremely cautious about further tightening (rate hikes), as marginal deterioration in the labor market could accelerate nonlinearly, triggering employment alarms.

5.2 Sources of Consumer Resilience

Meanwhile, consumer spending shows remarkable resilience. Despite gas bills doubling, American households continue to spend. This is mainly supported by two structural factors: excess savings accumulated during the pandemic (mostly exhausted among low-income groups) and wealth effects from stock market gains. Powell highlighted an interesting phenomenon: one of the drivers of economic growth is “the seemingly endless demand for data centers across the U.S.” Artificial intelligence-related investments are offsetting weakness in traditional manufacturing, which also explains why, despite consumer confidence hitting historic lows due to oil prices, actual spending remains robust.

6. The War of Wosh: New Framework, Balance Sheet Reduction, and Political Storms

6.1 Paradigm Shift in Policy Framework

After Powell steps down as Chair, the incoming Kevin Warsh will face a divided committee and a Powell who remains. Warsh has passed the Senate Banking Committee confirmation hearing, clearing key hurdles. His performance indicates he is preparing to implement a profound policy framework overhaul.

First, a philosophical reflection on inflation targets. Warsh characterizes the 2021-2022 inflation run amok as a “deadly policy mistake,” advocating for a “completely new inflation framework” emphasizing earlier and stronger efforts to anchor inflation expectations.

Second—and most critically—the “balance sheet runoff and rate cuts” strategy. Warsh has long opposed using the balance sheet as a stimulus tool. His core logic: shrinking the balance sheet by about $1 trillion is roughly equivalent to raising rates by 25/50 basis points. He advocates aggressively reducing the current large balance sheet (~$6.7 trillion) to tighten liquidity directly, creating space for rate cuts. This approach can satisfy the White House’s political desire for “rate reductions” while draining liquidity to prevent asset bubbles. Analysts predict that Warsh might push a policy combo of “shrinking the balance sheet by $1 trillion” and “cutting rates by 50 basis points” as a hedge.

6.2 Reshaping the FOMC Landscape

Warsh’s first challenge will be managing expectations within the FOMC. Powell said that Warsh made a “convincing statement” at the hearing and “I believe he can withstand political pressure.” But the political reality is harsh: nearly all Democratic senators oppose Warsh, viewing him as a potential “political puppet.” Within the Board, while Warsh’s appointment might tilt the committee toward a dovish stance (he has recently softened his attitude toward rate cuts), he faces hawkish forces like Harker, Kashkari, and Logan in regional Fed banks. Analysts expect that in his first year, Warsh may need to appear more dovish to balance internal hawks, especially if markets experience sharp corrections, prompting quicker responses.

7. Market Outlook: From “When to Cut Rates” to “Probability-Weighted Scenarios”

7.1 New Uncertainties

Post-meeting, market pricing has shifted markedly. Bond markets reacted swiftly, with the two-year Treasury yield experiencing one of the largest increases since 2022 on Fed decision day, with traders now pricing in about a 50% chance of rate hikes. The debate has moved from “when to cut” to “whether further hikes are needed.” This two-sided risk is rare in the Fed cycle over the past two years.

7.2 Scenario Analysis

Looking ahead, market trajectories will depend on how the following scenarios unfold:

Scenario 1: Conflict eases, supply recovers. If the Strait of Hormuz traffic normalizes and oil prices fall sharply below $80, inflation pressures will ease significantly. This would confirm Powell’s view that “energy shocks are temporary,” and the Fed might hold rates steady, with markets re-pricing a “soft landing,” and growth stocks (Nasdaq) potentially rebounding strongly.

Scenario 2: High oil prices persist, inflation remains stubborn. If the conflict stalls and oil stays above $100, this will turn into a sustained inflation input. The Fed would then have to keep rates high longer (“Higher for Longer”), possibly triggering Warsh’s “balance sheet reduction” move. Equity markets could face valuation and earnings pressures, with energy stocks serving as the best hedge.

Scenario 3: Oil prices break critical thresholds, triggering recession. If oil surges above $140, causing the “negative wealth effect” Powell mentioned, consumer spending could collapse. Markets would price in a “recessionary rate cut” early, leading to bond yields plummeting, gold surging after a brief inflation suppression, and stocks (excluding energy) falling sharply.

7.3 Long-term Structural Issues

Beyond oil prices, another long-term variable in Warsh’s era is the coordination of fiscal and monetary policies. Warsh has mentioned revisiting the 1951 Treasury-Fed agreement, hinting at possible debt management operations in his term. If the U.S. fiscal deficit continues to spiral, Warsh—who positions himself as an inflation fighter—may clash more intensely with the White House than Powell did.

In summary, the April 2026 Fed meeting is not just a pause but a fault line between old and new eras. Powell, as a “guardian,” seeks to preserve the institution’s integrity, while the upcoming Warsh era is full of paradigm shifts, aggressive balance sheet reduction, and geopolitical uncertainties. For investors, adapting to this high-volatility, two-sided risk “new normal” will be the key challenge in the months ahead.