Investors are currently grappling with a sharp reversal in expectations regarding Federal Reserve policy. Earlier in 2026, the market was pricing in two or three rate cuts, but that outlook has completely shifted. The latest CME FedWatch Tool now indicates approximately a 70% probability of a rate hike by December 2026, effectively taking rate cuts off the table. This dramatic repricing was largely triggered by strong May employment figures and persistent inflation, as indicated by the Consumer Price Index, which together provided no rationale for the Fed to ease policy.
While the June FOMC meeting concluded with no change to the federal funds rate, new Fed Chair Kevin Warsh intentionally provided minimal forward guidance. However, the subsequent market reaction was distinctly hawkish. The policy-sensitive 2-year Treasury yield rose relative to the longer end of the curve, with the 10-year Treasury yield hovering around 4.46% after rising nearly 5 basis points. Additionally, the updated Summary of Economic Projections showed nearly half of the FOMC members now foresee at least one rate hike in 2026, a significant jump from zero in March. Core PCE inflation forecasts were sharply raised from 2.7% to 3.3%, and overall PCE inflation to 3.6%, despite a slight downward revision in GDP growth for 2026 to 2.2% and a lower unemployment rate forecast of 4.3%.
The hawkish sentiment is also reflected in the increased market-implied probabilities for rate hikes. Even though the July meeting is still expected to see no change, the September meeting now has a 45% implied probability of a 25-basis-point increase to 4%. Derivative pricing suggests 25-50 basis points of additional tightening by year-end, with September identified as the earliest potential meeting for a hike. This shift has led to pressure on rate-sensitive sectors like semiconductors, REITs, and small caps, while the US Dollar has rallied, and bond yields have climbed. Gold prices have also declined in response to these developments.
