According to a research report from Guotai Haitong Securities Co., Ltd., persistent tariffs and geopolitical risks continue to disrupt U.S. inflation expectations. In the short term, the Federal Reserve's concern about "inflation" outweighs its worry about "stagnation," and suppressed expectations for interest rate cuts are likely to lead to volatility in U.S. stocks and bonds. However, due to the needs of the midterm elections, a weakening labor market, and the potential for tariffs and geopolitical risks to stabilize in the medium term, expectations for rate cuts may regain momentum in the second half of the year, though a definitive turning point still requires patience. The key points from Guothai Haitong are as follows.
On March 18, 2026, Eastern Time, the Federal Reserve released its interest rate decision from the FOMC meeting and the Summary of Economic Projections (SEP), followed by a routine press conference by Chair Powell. Analysis of the decision, the SEP, and Powell's remarks reveals five main marginal changes. First, the Fed's statement emphasized that the impact of the Middle East situation remains unclear, with Powell noting the difficulty in providing economic forecasts. Second, the SEP showed comprehensive upward revisions to both economic growth and inflation projections. Third, Powell did not acknowledge stagflation in the U.S. economy, with overall communication prioritizing "inflation" over "stagnation," indicating greater concern about upside risks to inflation than downside risks to growth. Fourth, while the Fed held rates steady as expected, maintaining the median forecast for one rate cut within the year, a majority of officials lowered their own projections for the number of cuts, and the possibility of rate hikes was discussed, reflecting a generally hawkish tone. Fifth, Powell reiterated the Fed's independence, and his decision on whether to continue serving as a Fed Governor remains pending.
Overall, the decision to maintain rates was largely in line with market expectations. The Fed's broad upward revisions to economic and inflation forecasts, coupled with a greater emphasis on inflation concerns than growth risks, resulted in a hawkish stance, further fueling market volatility. Short-term upside risks to inflation primarily stem from tariffs and geopolitical tensions, which are suppressing rate cut expectations. However, these factors are expected to be temporary, and expectations for rate cuts may increase in the latter half of the year.
Firstly, the impact of tariffs is becoming clearer. While former President Trump may re-impose tariffs through mechanisms like Section 122, 301, and 232, the overall magnitude is not expected to increase significantly. The Fed views the inflationary impact of tariffs as one-off and is not overly concerned about their transmission effects. Secondly, given the demands of the midterm elections, Trump has strong incentives to de-escalate the Iran conflict promptly. Thirdly, the Fed's primary focus remains on employment, inflation, and long-term interest rates. Although the labor market continues to show weakness, short-term inflationary pressures are currently hindering rate cuts. Further labor market softening would necessitate additional monetary easing; if tariffs and geopolitical risks stabilize, easing inflation expectations could create conditions conducive to rate cuts. Fourthly, the upcoming leadership transition at the Fed could also introduce some uncertainty.
The Fed currently maintains its projection for one rate cut within the year. The U.S. federal funds rate futures market, heavily influenced by short-term sentiment, is currently pricing in a possibility of no rate cuts. However, expectations for cuts may rebound in the second half of the year. U.S. Treasury yields are expected to experience short-term volatility at elevated levels before eventually declining as rate cut expectations resurface. The 10-year Treasury yield is projected to trend slightly lower, with a relative uptick after any preemptive easing cycle concludes. U.S. equities are likely to face continued short-term volatility, but may find support later as expectations for monetary easing build.
In the immediate term, constrained by inflation concerns, Fed rate cut expectations will likely remain suppressed, keeping U.S. Treasury yields elevated and volatile. Subsequently, as the Fed chair transition occurs and tariff and geopolitical risks potentially stabilize, rate cut expectations could reignite. The 10-year Treasury yield's central tendency is still expected to decline modestly, rising relatively after any preemptive rate cuts cease. U.S. stocks will likely experience ongoing short-term fluctuations, but could find support as easing expectations materialize. High short-term bond yields might pressure equity valuations, but the eventual resurgence of rate cut expectations and associated liquidity benefits could support further stock market gains. On one hand, Fed rate cuts would lower the risk-free rate, or discount rate, supporting stock valuations. On the other hand, the economic stimulus from lower rates would bolster corporate earnings, potentially reversing an economic slowdown and even initiating a recovery. In the short term, U.S. stocks will be influenced by geopolitical risks and liquidity conditions, suggesting continued volatility, with an upward inflection point still awaiting clearer signals.
Risk warnings include high short-term uncertainty surrounding Middle East geopolitical risks and the potential for new tariff risks if legal challenges to retaliatory tariffs succeed.
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