A Healthy Divergence

Geopolitical tensions continue to increase, driving up the price of oil, which climbed to over $78 per barrel for Brent crude this week. This presents an upside risk to inflation and a downside risk to growth. According to recent reports, President Trump will decide within two weeks whether and how to deepen U.S. involvement in the conflict, which may include missile strikes. The window for diplomacy suggests an opportunity for negotiation, which financial markets have welcomed — though the risk of escalation remains elevated. The change in the price of oil has been contained, and the current level sits below the 2025 high of over $82 per barrel.

Global supply appears ample in the face of slowing demand from diminished global growth expectations, and we don’t anticipate a major change in supply dynamics. However, supply disruption resulting from any activity in the Strait of Hormuz would change things materially. Iran has threatened to disrupt this critical oil transit lane should the U.S. enter the conflict. And even without Iran’s direct intervention to close the Strait, ships are avoiding the route, with insurance premiums for vessels using this route skyrocketing 60% since the conflict began. Vessels that are travelling through the Persian Gulf are reportedly experiencing interference with navigational signals and are on high alert. Many global energy companies are actively pursuing contingency plans and preparing for what could be a substantial supply shock, and U.S. officials are also preparing for the possibility of meaningful supply disruption. Thus far, these risks are only marginally reflected in the upward move in the price of crude.

The Federal Reserve left rates unchanged this week, as expected, in spite of growing criticism from the White House. The Fed still sees two interest rate cuts this year, but there is a growing difference of opinion on the Federal Open Market Committee (FOMC): Of the 19 participants, seven expect no cuts in fed funds rate in 2025, two expect one 25bps cut, eight expect 50bps of cuts, and two expect 75bps of cuts. Fed Chair Powell characterized the dispersion in opinion as a “healthy” divergence, representative of the high degree of uncertainty around the outlook. The current policy rate is 4.25% to 4.50%, so the median forecast of two cuts would bring fed funds rate to 3.75% to 4.00% by year end. However, this feels like a close call: Effectively, we are one dot away from changing the median forecast to no cuts this year.

The June Fed meeting also provided an opportunity for the Committee to update their Summary of Economic Projections. The Fed made changes to the growth forecast, but none of the 19 FOMC participants expect a recession. For 2025, the forecast for GDP growth is diminished from 1.7% in March to 1.4% currently, and it is accompanied by a slight increase in the forecast for unemployment to 4.5%. Similarly, the outlook for economic growth in 2026 has dampened to 1.6% amid higher unemployment of 4.5%. Notably, the outlook for inflation has worsened, with the median projection for core PCE, the Fed’s preferred measure of inflation, rising from 2.8% in March to 3.1% today. Fed Chair Powell warned that goods prices — an inflationary headwind over the past several months — are likely to rise faster given the tariff threat.

Fed Chair Powell seems very comfortable with the current positioning of monetary policy. Although he characterized uncertainty around the outlook as “diminished,” it is fair to say that the level remains elevated. He appears relatively sanguine about the outlook for growth, noting the resilience in the labor market as a key factor. We would agree generally that the labor market has proven to be remarkably resilient in the face of heightened uncertainty, but the weakening around the edges that is reflected in the initial and continuing claims data would indicate that caution is warranted.

Our outlook is generally consistent with the Fed’s dots, the Summary of Economic Projections and the decision to hold policy steady. The consistency is most acute in one critical area: we agree that the level of uncertainty remains high, the level of conviction on the outlook for growth and inflation is lower, and the range of outcomes is wider today than we typically forecast. We maintain a 60% probability that the U.S. economy avoids a recession, but that forecast is highly dependent on trade policy, which very much remains a wild card.

Apparently, zero interest rate policy, or “ZIRP,” is still on the table. The Swiss National Bank cut interest rates to zero this week — something that is unusual outside of an economic or financial crisis. One driver of this is the rapid appreciation of the Swiss franc, where flows from the U.S. dollar to the Swiss currency have driven the “Swissie” up versus the dollar over 11% year-to-date, and over 8% since April. The impact of a rapidly appreciating currency is felt in many ways, including through inflation. A stronger currency equates to importing deflation, as imports become cheaper.

This change in Swiss monetary policy is interesting on several levels, not least of which is that it reflects a major central bank willing and able to revert back to Global Financial and Covid Crisis levels of monetary policy — something many had suggested we would not see again in our lifetimes, outside of a crisis. ZIRP is back on the table as a policy tool — now a more conventional tool than just one to take out of the kit during a crisis.