Why we think a Fed hike remains unlikely

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US Treasuries came under pressure on Monday despite a drop in oil prices amid progress in US-Iran talks. Treasury yields rose across the curve, with the 10-year benchmark climbing 5 basis points to above 4.5%.

Markets continue to price in two interest rate hikes from the Federal Reserve by April next year, following Chair Kevin Warsh’s hawkish signals at the FOMC meeting last week. Investors are looking to May’s core personal consumption expenditures (PCE) data due later this week for further insights on inflation trends.

However, we still believe that the probability of near-term rate hikes is low. We see an extended period of policy on hold before a pivot toward lower rates in 2027.

Inflation should moderate as tariff effects have started to fade. The Fed revised its core PCE forecasts higher for this year and 2027 in its latest projections, and both the post-meeting statement and Warsh’s remarks emphasized that inflation is likely to remain above the central bank’s target for an extended period. But the inflation backdrop is combined with a stable labor market that was not presented as a primary driver of price pressures. This suggests the Fed does not see an immediate need to tighten policy in response to labor market overheating. Additionally, May’s consumer price index pointed to a re-emergence of core goods disinflation, with underlying details showing a clear deceleration in price increases in tariff-sensitive categories. This indicates that tariff pass-through, which had been a meaningful contributor to core inflation in recent quarters, is beginning to unwind, and it could reduce inflation trends by 0.8 percentage points over the next year.

Other parts of the US economy also point to a high hurdle for rate hikes. In addition to progress on core inflation, we expect softer growth conditions to re-emerge in the second half of the year, as diminishing fiscal support and weak real income growth weigh on household consumption. While our base case assumes a modest drag on labor demand from AI, the potential risk of larger labor market displacement may also shift the Fed’s focus back toward downside risks to employment. In our view, a sustained increase in inflation expectations, a reacceleration in growth above 2.5%, or a steady decline in the unemployment rate would be needed for a higher likelihood of additional tightening, but none of these conditions has been met at present.

The introduction of multiple task forces by Warsh signals a slower policy reaction in the near term. A central development from the FOMC meeting last week was the announcement of five task forces spanning communications, the balance sheet, data, productivity and labor markets, and inflation frameworks. These groups are intended to revisit core elements of how the Fed conducts and communicates policy, with most conclusions expected by year-end. We think this review process is likely to delay major policy adjustments as the Committee reassesses its framework and tools, and any lack of consensus among policymakers could further slow implementation.

So, we view current market conviction around Fed rate hikes as aggressive, and believe that current elevated yields offer an opportunity for investors to add to short- to medium-maturity quality bonds. Our view that the Fed policy rate would ultimately move lower also underpins our constructive medium- to long-term outlook on gold despite the near-term challenges it faces.