Formerly dovish Chicago Fed President Goolsbee has become one of the first officials to explicitly mention the possibility of raising interest rates. San Francisco Fed President Daly, also known for her dovish stance, emphasized that there is no single most likely path for interest rates. Fed Vice Chair Jefferson and Richmond Fed President Barkin believe that current interest rates are already close to a neutral level.
Analysts pointed out that the mere fact of mentioning the possibility of a rate hike already signifies an important shift in the policy balance.
A subtle but profound shift is occurring within the Federal Reserve's stance. Against the backdrop of rising oil prices driven by the Iran conflict and renewed inflationary pressures, several officials previously considered dovish, such as Goolsbee and Daly, have successively signaled hawkish tones, hinting that the Fed’s rate-cutting cycle, which began in September 2024, may have reached its end.
The latest developments show that Chicago Fed President Austan Goolsbee has become one of the first officials to explicitly mention the possibility of a rate hike. He stated that if inflation performs well, multiple rate cuts could still occur this year, but he also acknowledged "scenarios where rate hikes may be necessary." Mary Daly, the San Francisco Fed President known for her dovish stance, emphasized that there is no single most likely path for interest rates.
Another key rationale supporting the hawkish stance is the growing belief among officials that current interest rates are nearing or have already reached a neutral level. Fed Vice Chair Philip Jefferson noted that recent rate cuts "have brought interest rates roughly into the neutral range."
This shift in stance is directly impacting markets. Since the outbreak of the Iran war, long-term yields have surged significantly, prompting traders to raise their future interest rate expectations and slightly factor in the possibility of rate hikes this year. This change in expectations has quickly transmitted through bond yields to the real economy, subjecting businesses and households to higher financing costs, such as mortgage rates.
Analysts noted that while a rate hike remains a low-probability event, the mere fact that its possibility has been publicly mentioned marks an important shift in the Fed's policy balance.
Collective shift among dovish officials signals a clear tightening of policy guidance.
What is notable about this round of stance shifts is that the hawkish voices are mainly coming from officials previously regarded as neutral or even dovish.
Christopher Waller, a Federal Reserve Governor who was previously one of the strongest advocates for rate cuts, stated this month that the inflation risks posed by the Iran war led him to support holding steady at the March meeting.
Lisa Cook, another Federal Reserve Governor, pointed out that the Iran war has caused energy prices to rise, and persistently high inflation has once again become the primary risk facing the Federal Reserve.
Recently, Mary Daly, the San Francisco Fed President known for her dovish stance, wrote that the interest rate path conveyed by the Fed’s March dot plot "carries the risk of imparting false certainty," emphasizing that there is no single most likely path for interest rates.
Federal Reserve Chair Powell himself downplayed the reference value of the dot plot at a press conference this month, stating that "predictions should be treated with more caution than ever before."
The median forecast of the Federal Reserve's March dot plot indicates one more rate cut this year. However, statements from the aforementioned officials suggest that the credibility of this forecast is declining, and market interpretations are becoming increasingly cautious.
Another key rationale supporting the hawkish stance is the growing belief among officials that the current interest rate is near or has reached a neutral level.
Since September 2024, the Federal Reserve’s target interest rate has been cumulatively reduced by nearly 2 percentage points and now stands in the range of 3.5% to 3.75%.
Federal Reserve Vice Chair Philip Jefferson recently stated that the recent rate cuts have "brought interest rates roughly into the neutral range." Richmond Fed President Thomas Barkin said on Friday (March 27) that the rate cuts have placed "the federal funds rate at the higher end of the neutral range."
If interest rates are indeed at a neutral level, further rate cuts would imply substantial easing stimulus, which, against the backdrop of inflation not yet returning to the 2% target, risks fueling inflation. Deutsche Bank Chief U.S. Economist Matthew Luzzetti commented:
As the Iran war has intensified the Federal Reserve’s inflation concerns, the Fed currently has little reason to correct the market’s hawkish pricing. The market’s new expectation of stable or even rising interest rates is actually aligning with the Fed’s policy intentions.
Inflation exceeding targets for six consecutive years increases pressure on expectations management.
The persistence of inflation is the underlying reason for the Federal Reserve’s tightening stance. By the Fed’s preferred core measure, the current inflation rate is about 3%, having exceeded the 2% policy target for six consecutive years.
Officials are concerned that if the public forms long-term high-inflation expectations, such expectations could become self-fulfilling. At that point, merely waiting for tariff impacts or oil price declines would be insufficient to bring inflation back to target.
Derek Tang, an analyst at Monetary Policy Analytics, pointed out that Federal Reserve officials "are very reluctant to see a rise in inflation expectations," but the issue is that "they do not know how close they are to the tipping point."
The war in Iran has further exacerbated this risk. Rising oil and food prices directly affect consumers' daily experiences and are more likely to push up short-term inflation expectations.
However, there is currently no evidence to suggest that expectations have shown a systematic increase—although short-term inflation expectations rose somewhat in the University of Michigan's March consumer survey, long-term inflation expectations remained moderate.
Nevertheless, despite the increasing hawkish signals, some economists still believe that rate cuts this year are not hopeless. Weakness in the labor market provides some basis for rate cuts: non-farm payrolls fell by more than 90,000 in February, and the unemployment rate rose to 4.4%.
Christopher Hodge, Chief U.S. Economist at Natixis, stated, "The economy lacked strong momentum at the beginning of this year," and he still expects further rate cuts this year.
Moreover, if tensions in the Middle East ease, oil prices may retreat from their current high levels, and inflation is also expected to gradually move back toward the 2% target over time. If a sharp rise in oil prices further suppresses consumption and employment, the Federal Reserve may be forced to cut rates to prevent a recession.
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