Investors are bracing for a critical week ahead as the Federal Reserve prepares to navigate the delicate balance between a weakening U.S. labor market and persistent inflation that remains above target. This balancing act is poised to influence the momentum of the U.S. stock market rally, which has surged in recent months.
The S&P 500 has climbed nearly 20% since hitting its low on April 8, rebounding sharply after concerns over trade barriers eased following President Donald Trump’s “Liberation Day” announcement on April 2. However, the rally faced a setback on Friday amid a global stock sell-off triggered by Israel’s military strike on Iran, pushing investors toward safe-haven assets.
The Federal Reserve’s two-day monetary policy meeting, concluding Wednesday, represents the next major test for markets. While the central bank is widely expected to keep interest rates steady at the current 4.25%-4.50% range, investors will closely watch for any signals regarding potential rate cuts later this year.
Drew Matus, chief market strategist at MetLife Investment Management, emphasized the Fed’s challenge: “They need to encourage confidence in their ability to act without making firm promises.” He warned that premature rate cuts without clear evidence of economic weakening risk fueling inflation expectations.
At its May meeting, the Fed noted rising risks on both inflation and unemployment fronts. With its dual mandate to ensure full employment and price stability, markets are eager for clues on which priority may dominate and how that will shape the path of future rate decisions.
An important focus will be updates to the Fed officials’ economic and monetary policy projections, last published in March. Larry Werther, chief U.S. economist at Daiwa Capital Markets America, highlighted unemployment estimates as a key barometer. While Fed projections anticipated a 4.4% unemployment rate by the end of 2025, Werther forecasts a slight increase to 4.6%, citing recent softening in labor data such as jobless claims.
“If unemployment forecasts rise in line with recent labor market trends, and inflation remains near the Fed’s projections, it could pave the way for easing measures to support employment later this year,” Werther said.
Market expectations reflect this possibility, with futures indicating two rate cuts by year-end, potentially starting in September. This sentiment gained support from recent subdued inflation reports.
Investors are also watching developments around President Trump’s choice for the next Fed Chair. Although Trump has urged the Fed to lower rates, he recently stated he does not plan to remove current Chair Jerome Powell, whose term expires in May 2026.
Tuesday’s release of monthly retail sales data will offer further insight into consumer spending and potential inflation pressures from tariffs. A 90-day pause on many Trump-era tariffs is set to expire July 8, maintaining trade tensions as a source of market uncertainty. A recent trade truce between the U.S. and China has raised hopes for a durable agreement, though lack of detailed terms leaves room for future disputes.
Despite recent volatility, the S&P 500 remains up about 2% year-to-date and close to its all-time high reached in February. However, it was down 0.8% in Friday’s early trading as geopolitical and economic risks continue to weigh on investor sentiment.
