Federal Reserve dovish officials are turning against each other; has the rate-cut cycle already ended?

Questioning AI · Why are dovish officials turning hawkish under inflationary pressure?

Dovish officials have publicly mentioned the possibility of interest rate hikes, highlighting a subtle shift in Federal Reserve policy. Although the dot plot shows there will still be one rate cut this year, Powell also downplays its significance…

Despite the latest dot plot showing that Fed policy makers still expect to cut rates later this year, a closer look reveals another signal is emerging. Against the backdrop of tariffs and oil prices pushing inflation higher, and a labor market that has softened but not collapsed, some officials suggest that their next move could be either a rate hike or a rate cut.

This is a subtle but significant shift. Just a few weeks ago, the path for interest rates was still clearly pointing downward. But over the past week, multiple officials have released hawkish signals. Governor Cook, who has consistently aligned with the Fed’s majority camp, said that the rise in energy prices caused by the Iran war has further intensified inflation pressures, and persistent inflation has again become the Fed’s top risk.

Chicago Fed President Goolsbee became one of the first officials to explicitly mention the possibility of interest rate hikes. “If the inflation trend stays moderate, we may still return to a track of multiple rate cuts this year,” he told CNBC, “but I can also imagine a scenario that calls for rate hikes.”

Interest rate hikes are still a low-probability event for now, but even raising the possibility is worth watching. This month, Fed Chair Powell said that at the two recent meetings, officials did not choose to add the option of “possibly raising rates next” in their public statements.

Even if rates do not rise, the probability that the six consecutive rate-cut cycle that began in September 2024 has already ended is also increasing.

The market’s shift in expectations for the Fed is precisely why long-term interest rates have risen sharply since the outbreak of the Iran war. Traders have raised their expectations for future rates, even pricing in the possibility of a modest rate hike this year. As these expectations filter into bond yields, businesses and households have felt the impact immediately—such as higher mortgage rates.

Officials sometimes push back against market pricing that does not match their own policy expectations. But Matthew Luzzetti, Chief U.S. Economist at Deutsche Bank, says that because the Iran war has intensified inflation anxiety, the Fed currently has no reason to counter it. He believes that the market’s new expectations for rates to remain steady or move higher are favorable for the Fed.

What matters is that many of the recent hawkish remarks are coming from officials who were previously viewed as neutral or dovish. This month, Governor Waller—who has long strongly supported rate cuts—said that the inflation risks from the Iran war have led him to support holding steady through March.

The Fed releases a dot plot once per quarter, showing the 19 policy makers’ expectations for the year-end interest rate. Markets typically extract strong signals from it; in the March dot plot, the median expectation was for one more rate cut during the year.

But Daly, the dovish San Francisco Fed president, said this guidance could be misleading. In a post on LinkedIn, she wrote that it “may convey a false sense of certainty… making it harder for the public to clearly anticipate how the Federal Open Market Committee (FOMC) will react.” She added that there is no single most likely path for interest rates.

Powell himself has also downplayed the significance of the dot plot. At this month’s press conference, he said, “This time, we should be more cautious about our forecasts than usual.”

Of course, reasons to support rate cuts still exist. In February, the number of employed in the United States fell by more than 90,000, and the unemployment rate rose to 4.4%. Many economists believe that if tensions in the Middle East ease, oil prices will retreat from current levels, and inflation will continue to move down over time toward the Fed’s 2% target.

If oil prices rise sharply, it could deal a serious blow to consumer spending and employment, forcing the Fed to cut rates to avoid a recession.

Christopher Hodge, Chief U.S. Economist at Natixis, believes the Fed could still cut rates further this year. He said, “At the beginning of this year, the economy simply did not have very strong momentum.”

But multiple factors together are raising the bar for further rate cuts at the Fed.

Since September 2024, the target range for the federal funds rate has been cut by nearly 2 percentage points to 3.5%–3.75%. Further cuts would bring it closer to a neutral level where inflation is neither restrained nor stimulated.

Economists can only guess the exact level of the neutral rate, but more and more Fed officials say that rates may have already reached it. Vice Chair Jefferson said last Thursday that recent Fed rate cuts “have brought rates roughly into the neutral range.” Richmond Fed President Barkin said last Friday that after the rate cuts, “the federal funds rate is at the upper end of the neutral range.” If rates are indeed at the neutral level, further rate cuts would essentially mean exacerbating inflation.

Officials have also recognized that, as of this month, inflation has exceeded the Fed’s 2% target for six consecutive years, and they worry that the public may form long-term high-inflation expectations. Those expectations can become self-fulfilling. In this situation, simply waiting for the tariff shock or a retreat in oil prices is not enough to bring inflation back to 2%. By the Fed’s preferred gauge, current inflation is about 3%.

The Iran war has pushed up high-frequency consumer prices such as gasoline and food, further intensifying this risk. Derek Tang, an analyst at a monetary policy research firm, said that Fed officials “really do not want to see inflation expectations rise,” and “the problem is that they do not know how close they are to the point of losing control.”

However, the Fed can still feel some reassurance: there is currently no evidence that inflation expectations have risen sharply. Last Friday, a March consumer survey from the University of Michigan showed that although short-term inflation expectations increased slightly, long-term expectations have remained moderate.