This week delivered a potent mix of geopolitical relief, consumer and housing updates, and the Fed’s first rate decision under Chair Kevin Warsh. The U.S.–Iran memorandum of understanding eased pressure on energy markets. WTI fell to as low as $74/barrel on Thursday – down from $80/barrel last week – before climbing back to $77/barrel at time of writing on renewed fighting in Lebanon. As we note in our recent commentary, full normalization of oil markets is likely months away, and peace remains fragile. Intensified fighting between Israel and Hezbollah on Thursday led to the cancellation of planned U.S.–Iran talks in Switzerland today.

So far, consumers have remained relatively resilient to the gasoline price shock, partly shielded by higher tax refunds. May retail sales rose a stronger-than-expected 0.9% month-on-month. Higher prices again boosted the nominal headline, but this was not simply an inflation story (commentary). Real sales also moved higher (Chart 1). Still, with real disposable income down 1% from a year ago and credit card balance growth accelerating in March and April, some consumers are feeling stretched. Food store sales were flat and spending at bars and restaurants softened, with real food services and accommodation spending down from a year ago.

Looking ahead, consumers will welcome lower prices at the pump. The labor market also appears to be strengthening (commentary), while household wealth is supported by rising equity valuations. As we note in our latest forecast, this should help sustain consumer spending at a moderate 2% pace through year-end, roughly half a point below our pre-conflict expectation. May personal spending and income data due next Thursday will offer more detail on momentum. 

Housing remains the economy’s sore spot. Starts tumbled 15.4% in May to the lowest since May 2020 (commentary). The drop was exaggerated by volatile multifamily construction, but single-family starts also slipped and permits offered little encouragement. Even if some weakness reverses, mortgage rates near 6.5% leave builders and buyers cautious. 

Judging by this week’s FOMC statement, the rate environment is unlikely to ease soon. At Warsh’s first meeting as Chair, the FOMC held rates at 3.50%–3.75%, but communications leaned hawkish. In the economic projections, inflation was revised higher and growth lower this year, while the median “dot” now points to a possible hike later this year. Warsh also said the FOMC was “unambiguously and unanimously” resolved to fight inflation, reinforcing that price stability remains the priority. In a marked shift from the Powell-led FOMC, the statement was shortened substantially and forward guidance was dropped. The new Chair also announced five new task forces to review Fed communications, the balance sheet, data sources, productivity and labor markets, and inflation frameworks. The lack of forward guidance left investors with less information about the Fed’s reaction function. Without it, markets appear to have keyed in on the statement’s conclusion that “the Committee will deliver price stability”: the probability of a rate increase by September jumped to 73% after the decision, up from about 27% (Chart 2).