Market expectations for Federal Reserve interest rate cuts within the year have significantly cooled, influenced by energy price shocks and recurring inflation. A recent survey indicates most economists believe the Fed will refrain from cutting rates this year, pushing expectations for easing into next year. Respondents broadly view the current inflation uptick, linked to the Iran conflict, as "transitory."
The federal funds rate has remained in the 3.50%-3.75% range since last December. Currently, less than half of surveyed economists anticipate a rate cut this year—a stark contrast to last month when over two-thirds expected at least one cut. Despite this shift, economists' overall outlook on rates remains relatively dovish. They continue to believe the inflation driven by surging energy prices since the outbreak of the Iran conflict two and a half months ago is temporary and unlikely to spread more broadly to other consumer goods prices.
Among the 101 economists surveyed between May 14 and 19, nearly 85% (83 individuals) expect the benchmark rate to stay unchanged within the 3.50%-3.75% range through the third quarter. This compares to just over half last month and nearly 70% in March who expected at least one cut by then.
Aditya Bhave, Head of US Economics at Bank of America, stated, "Both a hike and a cut are possible... The base case is for rates to remain unchanged, and frankly, the gap between the other two options is very small. It feels like if the Fed's next move is a cut, it's more likely to happen next year rather than this year." He added, "Upside risks to inflation do exist... We are not geopolitical experts, nor commodity forecasters. There is clearly a lot of uncertainty in our forecast."
During the Fed's April meeting, three policymakers dissented, advocating for the removal of language from the policy statement that leaned towards rate cuts, while another voted for an immediate cut. Since then, Fed officials have largely advocated for holding steady, citing uncertainties related to the ongoing US conflict with Iran.
Economists note that, in any case, incoming Fed Chair Kevin Warsh is unlikely to deliver the rate cuts desired by President Trump. Regarding the year-end rate level, economists have not reached a clear consensus, but nearly half (49 out of 101) expect no adjustments this year, up from about one-third previously. Nearly one-third anticipate one rate cut this year, mostly in December. Four economists forecast at least one rate hike.
**Bond Market Hike Bets Seen as "Overreaction"**
In contrast to economists' expectations, the bond market had priced in the possibility of Fed rate hikes this year. Spurred by inflation data, the 30-year US Treasury yield surpassed 5%, the 10-year yield climbed to a 15-month high above 4.6%, and the 2-year yield also hit a recent peak. Federal funds futures briefly pushed the probability of a rate hike this year to around 50%, with some contracts even pricing in a 25-basis-point hike as early as December or late January next year.
Many strategists have expressed clear doubts about this market movement, seeing a significant "overreaction." A core criticism is the exceptionally thin trading volume in far-forward rate contracts.
Will Compernolle, Macro Strategist at FHN Financial, pointed out that far-month contracts have extremely poor liquidity. For example, May 2026 contract volume this month was about three times that of January 2027 contracts, with some even more distant contracts seeing only a few thousand trades. "This is a low-confidence signal; the market may simply be hedging against potential hike risks."
Ryan Swift, Chief US Bond Strategist at BCA Research, similarly noted that financial markets digest information much faster than actual data evolves. Sometimes they correctly anticipate signals, but "more often than not, it's just an overreaction."
**Inflation Expectations Revised Higher but Still Seen as Temporary**
For economists, inflation remains the biggest variable. US inflation is currently more than one percentage point above the Fed's 2% target and has been for over five years. The Fed's preferred inflation gauge, the Personal Consumption Expenditures (PCE) Price Index, latest annual rate is 3.5%, the highest since May 2023.
Economists now expect the year-over-year increases for the PCE index in Q2, Q3, and Q4 to be 3.9%, 3.7%, and 3.4%, respectively. These forecasts are about 25 basis points higher than last month's projections, marking the third consecutive upward revision.
In a smaller sample survey, nearly 86% of respondents believe current inflationary pressures are temporary, but opinions are divided on whether this situation will change.
Scott Anderson, Chief US Economist at BMO Capital Markets, said, "As economists, our recent forecasting record on inflation hasn't been good. We may be in a new era where we face shocks more frequently, which is a significant risk."
Additionally, economists' expectations for unemployment and economic growth remain largely unchanged. They forecast an average unemployment rate of 4.3% or slightly higher in the coming years (close to current levels) and average economic growth of about 2%.
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