The Federal Reserve is about to shift. At the June 17 FOMC meeting, the Fed looks set to drop its easing bias and signal a willingness to raise rates as early as July.
The bond market, reading this as evidence that policymakers are taking inflation seriously, should take the news in stride. And perhaps most surprisingly, small-cap stocks – which are historically sensitive to rate moves – may not flinch much either.
Here’s why I think that’s the right read, and what it means for your investments right now.
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The April Minutes Were a Clear Warning Shot
The ongoing closure of the Strait of Hormuz, combined with a string of stronger-than-expected economic data, has shifted the Fed’s thinking. Upside risks to inflation now appear to outweigh downside risks to employment.
The April FOMC minutes made this plain to see. Many participants indicated they would have preferred to remove the easing-bias language from the post-meeting statement altogether.
That language survived, but just barely – and certainly not by consensus.
The debate inside the committee has clearly moved on. Rate cuts are effectively off the table. The dominant discussion was how long to hold rates and whether or not to tighten.
In short, the April minutes show a committee that is acutely aware of its credibility and willing to act to preserve it.
Where the Market Currently Stands
The CME FedWatch Tool currently assigns only an 11% probability to a rate hike at the July meeting. That seems too low to me, given what the April minutes revealed.
The tool shows a 27% probability of a hike in September, and – perhaps most telling – a 53% chance of at least one hike by year-end.
My read is that the June meeting will be the turning point. The Fed will remove its easing bias and make clear that the next most likely move is up, not down. The bond market should welcome this as evidence that the Fed is staying ahead of the inflation problem, rather than falling behind it.
Why Small Caps Are Holding Up
Small-cap stocks tend to be more sensitive to interest rate moves than large caps, largely because of their higher reliance on floating-rate debt. That sensitivity is one reason small caps led the market off the late-2025 rate cuts.
It’s reasonable to ask why the recent rise in bond yields and the growing threat of a rate hike haven’t sent small-cap stocks lower.
The most likely explanation is earnings momentum.
Investors appear to believe that the resilient economy – supported in part by the ongoing AI build-out – is more than enough to offset the drag from modestly higher rates.
The numbers back that up. Earnings in the S&P 600 SmallCap Index are expected to grow more than 15% this year, followed by 19% in 2027 and 14% in 2028.
The S&P 500 tells a similar story: Estimated 2026 EPS sits at a record $333.16, representing growth of 23.3%, with further gains of 15.4% and 12.2% projected in 2027 and 2028, respectively.
Margins are holding up as well. The S&P 600’s expected EBITDA margin is north of 15% this year and should hold firm next year too. The S&P 500’s sits at 24.5% for 2026 and is projected to widen to 26.2% in 2027 – a sign that AI-driven productivity gains are showing up in actual results.
At the same time, valuations are reasonable. The S&P 600 trades at just 16.5 times estimated 2026 earnings. The S&P 500 trades at 21.1 times forward EPS. Neither multiple looks stretched given the earnings trajectory.
What to Watch This Week
We’ll know more by Thursday. April’s core PCE deflator – the Fed’s preferred inflation gauge – is due out, and it matters.
Core PCE ran at 3.2% year over year in March, up from 3.0% in February. Given that the latest CPI and PPI readings both came in above expectations, a further uptick seems likely and would increase the probability of a rate hike.
Eight Fed officials are also scheduled to speak throughout the week. Their remarks will carry a lot of weight for investors trying to gauge the Fed’s next move.
The big wild card to all this is a potential peace deal that could reopen the Strait of Hormuz. Talks are reportedly ongoing, with a memorandum of understanding under discussion as a first phase.
But the two sides remain far apart on key issues, and any agreement would likely take 30 to 60 days to develop further. Progress on that front could change the inflation picture, but probably not by the June FOMC meeting.
Putting It All Together
The Fed’s thinking is shifting. A rate hike is no longer some fringe idea – it’s becoming a base case for later this year. The good news is that a Fed that is serious about its inflation mandate – and projecting independence – is ultimately the best thing for markets. And a small-cap earnings backdrop as strong as the current one shouldn’t be easily broken – even if we get a rate hike this year.
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