The Fed's Latest Inflation Outlook Offers Wall Street Its First Relief in Months

Interest rates are likely headed higher later this year. That's the chief takeaway from the Federal Reserve's most recent public assessment of the United States' economy, anyway.

In its projection of key economic numbers released on Wednesday, the Federal Open Market Committee (FOMC) indicated it expects the federal funds rate to reach 3.8% (a range of 3.75% and 4%, to be specific) versus the current target range of 3.5% to 3.75%, up from March's full-year projection of 3.4% (3.25% to 3.5%). And data from interest rate futures exchange CME says the market's now making the same bet, with that quarter-point rate hike expected more than not by the end of September.

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Higher inflation, but the economy chugs along

Inflation isn't expected to abate in the near future either. The same FOMC projection, in fact, suggests 2026's inflation rate is apt to roll in at 3.6%, up from March's expectation of 2.7%. That's why interest rates are expected to inch higher by the end of the year -- to combat inflation.

The funny thing is, uncomfortably high prices of ... well, everything don't seem to be taking a serious toll on the economy. As the Federal Reserve's statement on its decision to leave the fed funds rate untouched this month explains:

Economic activity is expanding at a solid pace despite elevated uncertainty that owes, in part, to the conflict in the Middle East. Productivity growth and capital investment are strong. Job gains have kept pace with the workforce, and the unemployment rate has changed little.

As long as this remains the case amid the current inflationary headwind, the domestic economy should come out the other side on a reasonably solid bullish footing. And this increasingly looks like the outcome we'll see sooner than later.

There is relief that relief is possible in 2027

The FOMC also expects inflation to cool quite a bit in 2027, and then fall a little more -- to 2% -- by the end of 2028. The fed funds rate should fall during this two-year time frame as well, to a more palatable average target of 3.4% ... although the futures market isn't quite making that same bet just yet. Other interest rates, like mortgage rates, will then fall accordingly.

More important to investors than the specifics of the Fed's assessment of the economy and how future inflation will impact future interest rates, this optimism tacitly says it's safe enough to remain in the market.

But that doesn't mean stocks won't suffer measurable setbacks in the foreseeable future. Regardless of inflation (or lack thereof), the market is technically overbought and fundamentally overvalued. We're due for a correction, even if it's not a devastating one. We just don't know when we'll get it.

Whatever the case, the Fed's latest inflation outlook really is welcome relief to investors. Things aren't quite as bad as they seem or feel on the surface. We may well sidestep a bear market-inducing economic environment.

James Brumley has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends CME Group. The Motley Fool has a disclosure policy.