The Fed Removed This 1 Key Phrase From the Inflation Report. What That Means for the Market.

On June 17, the Federal Reserve held its fourth Federal Open Market Committee (FOMC) meeting of the year. It was also the first Fed meeting chaired by Kevin Warsh, who was nominated by President Trump and succeeded Jerome Powell on May 22.

The Fed kept the benchmark rate unchanged at 3.50%-3.75%, which probably didn't surprise many investors, given that inflation hit a three-year high of 4.2% in May. But Warsh also broke with his predecessors, halting the Fed's forward guidance on the economy and refusing to submit his own interest rate projections.

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The Fed also shortened its official statement and explicitly removed any references to "easing bias" -- which strongly suggests that interest rate cuts (monetary easing) would be off the table for the foreseeable future. Let's see what that shift might mean for the broader market.

Elevated interest rates will weigh down the market

The Fed aims to keep inflation at around 2%. When inflation exceeds the target, the Fed usually raises rates to temporarily throttle economic growth and reduce inflation. Once inflation cools, the Fed will reduce rates again to spur fresh lending and economic growth.

Therefore, higher interest rates make it harder for companies to expand, and their stocks become less attractive investments. Higher rates also make dividend-paying stocks less attractive than safer, higher-yielding CDs, T-bills, and other fixed-income investments.

That's why Vanguard's S&P 500 ETF (NYSEMKT: VOO) -- the biggest S&P 500 ETF -- stagnated in 2022 and 2023 as the Fed hiked its benchmark rates 11 consecutive times, from nearly 0% to 5.25%-5.50%. But when the Fed cut those rates six consecutive times, from 5.25%-5.50% to its current level of 3.50%-3.75%, the market stabilized.

Why the Fed is making a smart move

In the past, the market often reacted to the Fed's future expectations rather than hard economic data. By refusing to offer any more forecasts and removing the phrase "easing bias," Warsh wants the Fed to simply react to the established economic data.

In the official statement, the Fed says it "will carefully assess incoming data, the evolving outlook, and the balance of risks" to decide future interest rate adjustments. That stance will likely disappoint President Trump, who repeatedly pressed Jerome Powell to cut interest rates. Still, it's a responsible one that recognizes the risks of badly timed interest rate cuts -- which can exacerbate inflation and severely weaken the U.S. dollar.

Therefore, elevated or higher interest rates could limit the market's gains this year. But over the long term, they're required to keep the market growing steadily without overheating.

Leo Sun has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Vanguard S&P 500 ETF. The Motley Fool has a disclosure policy.