ECONOMICS : US: What to expect when you're expecting rate hikes

Research evidence excerpt

ECONOMICS : US: What to expect when you're expecting rate hikes

Refinitiv

Since January, we have looked for the FOMC to keep rates on hold well into 2027 based

on expectations for resilient growth, a stable labor market and sticky inflation (see

January FOMC: The wind blows a little bit warmer, dated 29 January). While we were

skeptical that inflation would find its way all the way home to 2% under a long-term hold,

we thought the FOMC would tacitly accept an enduring moderate overshoot as a price it

needed to pay to mitigate risks to employment. 1

Over the course of the year, and especially since the start of the Iran war, the challenges

the FOMC will face in returning inflation to 2% have become more evident. Its current

policy stance, calibrated in September 2025 as part of a planned program of three rate

cuts, aimed to provide insurance to an economy that was expected to be cyclically weak

following the imposition of tariffs and in which inflation was thought likely to cool in 2026 to

close to 2%. Instead, in part because of the war but also due to tariff pass-through and

entrenchment of pandemic-era inflation into services, PCE inflation appears likely to run

closer to 4% than 2%, demonstrating a persistent inflation problem and leaving monetary

policy much more stimulative in real terms than anticipated. This unexpectedly high level

of real stimulus comes to an economy that seems to need much less of it than was thought

in September, with the labor market not ‘flashing red’ as had been expected. 2

While we see monetary policy as poorly positioned to deal with the economic outlook

as it is, our longstanding view is that the FOMC would hike rates only if

unemployment seemed likely to decline below 4%, a level at which wage-price