Fed Minutes Hawkish, Inflation Elevated, US-Iran Conflict Grimmer: Why FOMC Will Still Hold Rates In 2026?

The US Federal Reserve's minutes of the July meeting signalled a hawkish stance going ahead, in line with expectations due to a clear dissent witnessed in the previous policy. The Kevin Warsh-led FOMC continues to believe that inflation risks pertain and its outlook is uncertain amidst the re-escalation of conflict between the US and Iran. While they assessed the labour market, conditions are broadly stable. They hinted at policy tightening if inflation did not decline meaningfully. As per economists, they still project the FOMC to keep rates unchanged throughout 2026.

"The minutes to the July FOMC meeting were expected to be relatively hawkish, given three members voted for an immediate hike. However, the minutes reflect the views of the overall committee. We strongly suspect the members that are voting this year lean more dovish, especially given the poor jobs, benign inflation and weaker consumer numbers of late," said James Knightley, chief international economist at European banker, ING.

US Fed Minutes Key Highlights

FOMC is worried about the West Asian war and its grave impact on inflation, that has turned them hawkish.

West Asia War Hindrance to Achieving 2% Inflation Target:

"Participants judged that their inflation outlooks were highly uncertain and that inflation risks were skewed to the upside. Many participants noted that the recent re-escalation of the conflict in the Middle East significantly clouded the inflation outlook," said the Fed minutes statement.

Also, the FOMC remarked that a protracted conflict could prolong supply chain challenges and could put upward pressures on inflation.

They also highlighted that the possibility that, after several years of inflation above 2 per cent, continued elevated inflation rates could begin to affect inflation expectations and wage- and price-setting decisions.

"Several participants remarked that successive supply shocks have repeatedly delayed the expected return of inflation to 2 per cent in recent years, adding to concerns about persistently elevated inflation," Fed minutes said.

As per the ING's note, the minutes to the July Federal Reserve FOMC policy meeting lean a touch hawkish, but that was to be expected given three officials had dissented. Beth Hammack, Lorie Logan and Neel Kashkari had all voted for an immediate 25bp interest rate increase, while nine other committee members voted to hold the Fed funds range at 3.5-3.75%. The minutes showed "several participants" favoured a rate hike and "many" assessed that rate hikes would likely be needed if inflation didn't decline. In the end, though, "most" supported holding rates steady.

US Labor Market Stable But AI Keeps Both Hiring & Firing Low

However, Fed minutes indicated that the labour market conditions were stable with demand and supply in balance. Also, the unemployment rate remained relatively stable.

But they also remarked that uncertainties associated with AI-related developments as well as current and anticipated productivity gains were keeping both hiring and firing low. They observed that, in sectors connected to the ongoing AI buildout, there was strong demand for skilled workers – including electricians, machinists, and engineers – leading to notable increases in their wages. A few participants noted some lingering signs of softness in the labour market, including the low job-finding rate and the persistently elevated long-term unemployment rate.

Nonetheless, overall, nominal wage growth was moderate and consistent with inflation moving toward 2 per cent, but a few FOMC members signalled upside risks to wage growth going forward.

Fed Remains Hawkish:

"With regard to the outlook for monetary policy, participants reiterated that their interpretations of incoming information would be a key component of their deliberations. Many participants assessed that policy tightening would likely be necessary if inflation did not decline," said Fed minutes.

Some FOMC members believe that financial conditions might not currently be sufficiently restrictive to facilitate a return of inflation to 2%, while some suggested that financial conditions had tightened over the intermeeting period and that this development was partly a reflection of strong economic growth and market expectations that the Committee would adopt a more restrictive policy stance before long.

While a few FOMC members have favored raising the target range for the federal funds rate at this meeting judged that doing so would likely help forestall the need for a steeper and potentially more costly sequence of tightening moves at a later stage.

Will Fed Hike Rates In 2026?

ING's economist pointed out that in the Fed minutes, with respect to the balance of risks for employment and growth, they were viewed as being "skewed to the downside", while for inflation the risks to Fed forecasts are "skewed to the upside". In terms of inflation, the things officials are watching, energy prices and developments in the Middle East are of top concern. There is also a wariness that the AI investment binge could also keep inflation elevated due to higher microchip prices feeding through into inflation more broadly via smart phones, computers and electricity. However, "several" did say the tariff price hike pass through was now complete.

Despite the slightly hawkish tone, Knightley said, "we must remember these minutes reflects views held before the latest round of poor jobs numbers, subdued inflation prints and disappointing retail sales/consumer confidence figures. Moreover, these minutes represent the broad views of the Fed and not everyone votes at the FOMC meetings."

The economist pointed out that of the nine that think they will hike, we suspect only three are voting members this year - and they are already voting for a hike! The implication is that none of the other six predicting they will hike have a vote on the matter this year. For the Federal Reserve to deliver an interest rate hike, the jobs and inflation data needs to convince those that were saying "no hikes" to change their minds.

"That needs stronger jobs numbers and more elevated inflation, which we are not predicting. Hence, our view that the Fed will instead keep rates on hold well into 2027," said the economist.