The Federal Reserve has little appetite to cut interest rates in the near term. Minutes of the January meeting show policymakers are increasingly concerned that inflation could stay above the 2 percent target for longer than expected. Markets might have to reprice their expectations, economists said.
Most officials described the risk of persistently elevated inflation as “meaningful,” suggesting that further easing is off the table until price pressures show clear and sustained improvement. While Trump-appointed governors Stephen Miran and Christopher Waller dissented, preferring a quarter-point cut, some FOMC members even raised the possibility of renewed rate increases if disinflation stalls.
Yet derivatives markets continue to price in two quarter-point cuts this year, according to the CME FedWatch tool. Several large institutions said that looks optimistic. Michael Feroli, chief U.S. economist at JP Morgan, no longer expects any cuts before 2027 and sees the policy rate holding at the current level of 3.5 percent to 3.75 percent through 2026. “The proposition that rates are restrictive looks increasingly untenable,” he wrote in a note to clients, arguing that a tightening labor market would make near-term easing unlikely. In fact, the Fed is projected to hike rates by 25 basis points in the third quarter of 2027, according to JPMorgan, bringing the upper band for the policy rate back up to 4 percent.
Macquarie, Australia’s largest asset manager, sides with JP Morgan in the Fed rate debate. Chief economist Ric Deverell has argued that as tariff effects fade and global industrial production recovers, growth will pick up and central bank easing will end. In that scenario, he said, the Fed will “likely be hiking again in late 2026.” If that proves correct, current market pricing would need to adjust sharply.
Markets vs. economists
The divergence between rate futures and sell-side forecasts has widened in recent weeks. Barclays and Morgan Stanley have both pushed their expected first rate cut to mid-2026 at the earliest. At Pimco, economist Tiffany Wilding said officials are “in a good place to react to incoming developments,” but stressed there is “no sense of urgency” to ease. Goldman Sachs Research still pencils in two cuts this year, though it frames that view as conditional on labor market weakness and acknowledges “near-term uncertainty.”
Luc Aben, chief economist at Van Lanschot Kempen, is optimistic but not ready to endorse the market’s assumption of two rate cuts just yet. “We shall see,” he said. If the strong labor market reports of recent months are confirmed, both in job creation and wage growth, “the picture could look different.” If the policy rate does come down, it will probably not happen before the start of the second half of the year, said Aben.
Inflation still above target
Aben underlined that investors may be focusing on the wrong inflation gauge. The Consumer Price Index tends to dominate headlines, but the Fed’s preferred measure is the Personal Consumption Expenditures Price Index, or PCE, which tracks price developments based on actual consumer spending patterns.
The Fed minutes showed core PCE inflation running at almost 3 percent in December. That is a full percentage point above target. Officials attributed part of the stickiness to tariff-related goods prices, which many expect to fade by midyear.
Several policymakers cited businesses planning further price increases in 2026 due to ongoing cost pressures. Others warned that easing policy while inflation remains elevated could be misinterpreted as implying “diminished commitment” to the 2 percent goal.
In the short term, fewer rate cuts than expected could create headwinds for equities, according to Aben. “But overall the picture remains positive,” he added. Equity markets are ultimately driven by corporate earnings, which depend on economic momentum. That, he argued, should offset disappointment if the Fed proves less dovish than investors currently anticipate.
Labor market stabilizes, but fragile
The unemployment rate stood at 4.4 percent in December. Most FOMC-members saw signs of stabilization rather than renewed weakness. Layoffs remain low, but hiring is subdued.
Governors Waller and Miran argued that policy remains meaningfully restrictive and that downside risks to the labor market deserve more weight. Other officials warned that a low-hiring environment could make the labor market more vulnerable to shocks. If demand softens, unemployment could rise quickly. Business contacts also pointed to uncertainty around artificial intelligence and automation as factors holding back recruitment.
For fixed income investors, that mix complicates positioning. A resilient labor market supports the case for higher-for-longer rates. A sudden deterioration would revive the easing narrative.
The Warsh factor
According to Mohamed El-Erian, former CEO of bond giant PIMCO and adviser to Allianz, the increasingly divided Fed is “reflecting both the complexity of the current economic landscape and the ‘lame duck’ status of the outgoing chair,” he wrote on LinkedIn.
President Donald Trump has nominated Kevin Warsh, a former Fed governor and critic of large-scale asset purchases, to succeed Jerome Powell when his term expires in May. Warsh has argued that successive rounds of quantitative easing inflated asset prices and widened inequality.
Feroli expects Warsh initially to argue for rate cuts but says his stance could shift. “As time goes on, his leanings will be more open to revision and perhaps reversion back to a more hawkish view,” he said, particularly after the midterm elections.
Warsh’s confirmation faces political hurdles. Senator Thom Tillis has said he will oppose confirming any Fed member until an investigation into Powell is resolved. Without a confirmation vote, Powell could still remain in office beyond May.