In 2026, FOMC voting member Paulson "hawkish": inclined to keep interest rates unchanged, with the premise of lowering rates being continuous progress in fighting inflation.

As Philadelphia Fed President Anna Paulson, a voting member of the Federal Open Market Committee (FOMC) for the 2026, said she is inclined to keep interest rates unchanged and believes that a rate cut would only be appropriate if progress is made in the fight against inflation. Paulson said on Tuesday, "Current monetary policy has a mild restrictive effect, which is helping to curb inflationary pressures while the labor market remains stable." "Keeping interest rates unchanged allows us to assess how the economy is evolving, as well as the risks facing price stability and the labor market." She noted that the unemployment rate has been "exceptionally stable," indicating that the labor market is "basically balanced," and that inflation levels were already high even before the Middle East conflict raised energy prices. She added, "Assuming the labor market continues to remain balanced, a rate cut would only be appropriate after we see sustained progress in inflation." In recent days, global bond yields have risen sharply as markets react to persistently high energy prices and increase bets on a Fed rate hike. Paulson said, "I believe market participants are starting to accept the possibility that the federal funds rate may remain unchanged for a longer period of time, or even that further tightening may be necessary, which is a healthy development." Paulson said she expects the labor market to remain stable and price pressures to gradually fall back to the 2% target level. However, she also pointed out that the risks to achieving the inflation target have increased. She emphasized that the future path will depend largely on how long disruptions to oil and other commodity supplies from the war continue. She said, "If the Middle East conflict can be resolved quickly, shipping and oil production will quickly return to normal, and inflation as well as inflation risk are likely to recede quickly." "But if the conflict takes longer to resolve, inflation and inflation risks, as well as risks to the labor market, may remain elevated for a longer period of time." Paulson also mentioned that households are facing pressure from high energy prices, with many consumers shifting frequently from high-end brands to cheaper brands, and some households increasingly relying on credit cards to maintain their consumption levels. However, she said that despite these pressures, overall consumption is still showing resilience. She said, "While many households are feeling increased pressure due to inflation, there is almost no sign that consumers are significantly cutting back on spending." Paulson is the latest Fed official to release hawkish remarks. Prior to this, several officials have been signaling a hawkish stance. Kansas City Fed President Schmid said last Thursday that inflation is the biggest risk facing the U.S. economy. Minneapolis Fed President Kashkari said last Wednesday that the Middle East conflict has exacerbated already high inflation, and the Fed must bring inflation back to the 2% target. Boston Fed President Collins also warned that if inflation pressures do not ease, the Fed may need to raise rates again. Chicago Fed President Gursby pointed out last Tuesday that inflation is moving in the wrong direction, and this incorrect development is not only reflected in oil-related aspects, but also in tariff-related aspects. These officials' emphasis on inflation all points to one view, that the Fed is paving the way for possible rate hikes. Inflation concerns reignite Fed rate hike expectations The latest data released last week confirmed the inflationary pressure facing the U.S. economy. Ongoing spikes in gasoline prices due to the Middle East conflict and soaring grocery costs have continued to drive inflation higher, with the Consumer Price Index (CPI) rising 3.8% year-on-year in April, the fastest pace since 2023. Meanwhile, the Producer Price Index (PPI) leaped 1.4% month-on-month in April, the largest monthly increase since March 2022, well above market expectations of 0.5%; the year-on-year increase reached 6.0%, the highest level since December 2022, significantly exceeding the market's expectations of 4.8%. The drastic changes in oil prices and the inflationary environment have led the market to make a historic reversal in pricing the Fed's policy path. Just before the outbreak of the Middle East conflict in February, overnight index swap markets indicated that traders generally expected the Fed to cut rates by about 50 basis points for the full year of 2026. However, the energy shock from the war has completely changed the outlook for interest rates. Swap contracts show that the Fed is likely to raise rates by around 20 basis points by the end of the year, with an 80% probability of a 25 basis point rate hike; the market now fully expects a 25 basis point rate hike in January 2027, earlier than previously anticipated. In fact, the shift in expectations for Fed policy has long been evident in internal Fed divisions. The FOMC meeting last month saw the highest level of dissent since 1992, with as many as three officials voting against a policy statement biased toward easing. Even the most dovish Fed Governor Milan has significantly softened his stance, lowering his expectations for rate cuts. The upcoming new Fed Chairman Wash's stance has also attracted widespread attention, with the market generally expecting him to face a difficult policy choice when he takes office. Several Wall Street giants have recently delayed their forecasts for Fed rate cuts. These banks believe that the employment and inflation data support reasons for the Fed to keep rates unchanged at least until the end of this year. For example, Adiya Bave, head of U.S. economic research at Bank of America, wrote in a report last week, "The data simply do not support rate cuts this year. Core inflation rates are too high and rising. The strong April jobs report was the final straw, especially considering the hawkish comments from Fed officials." Bave and his colleagues now expect the Fed to make another rate cut in July 2027, a significant shift from the previous expectation of a rate cut in September of this year. The current consensus suggests that the Fed has entered "defensive mode." Interest rates will remain at 3.50%-3.75% or even higher until the path to a return to the 2% inflation target becomes clearer. Statements after the April rate decision indicate that the internal divisions within the Fed between "anti-inflation" and "growth stabilization" have reached their most severe levels in years. The June policy meeting will be a key window to observe the new Fed Chairman's policy style, but in the face of stubborn inflation and geopolitical risks, the policy is likely to remain on hold in the short term. The minutes of the April Fed meeting will be released at 2 a.m. Beijing time on Thursday, May 21. As inflation pressures show signs of worsening and the possibility of rate hikes instead of rate cuts increases, this meeting minutes will be closely watched. Market investors hope to find clues in them regarding the possibility of rate cuts or even rate hikes in the context of high energy prices. Forewarned or an overreaction? Bond market preemptively hikes rates for Wash The U.S. Senate voted last Wednesday to confirm Kevin Wash as Fed Chairman, paving the way for him to lead the Fed. Wash has stated that he plans to implement "structural reforms" at the Fed, including strengthening coordination with the Treasury Department and the Trump administration on non-monetary policies, and pushing for the Fed to reduce its balance sheet, which he believes will create room for rate cuts. However, before Wash has even chaired his first monetary policy meeting at the Fed, the bond market has already sent a "rate hike gift." With inflationary pressures escalating due to soaring energy prices since the Middle East war broke out two and a half months ago, U.S. bond yields have risen rapidly in recent days. Currently, the yield on 10-year U.S. Treasuries has risen to 4.665%; the yield on 30-year Treasuries has risen to 5.180%. The yield on 2-year U.S. Treasuries, which is sensitive to monetary policy, is reported at 4.108%, higher than the upper limit of the Fed's target rate range. In normal situations, the 2-year Treasury yield will not continue to exceed the Fed's target rate range, and this abnormal situation indicates that the market has already carried out a round of rate hikes before Wash's first policy meeting (scheduled for June 16-17). This round of repricing in the bond market is depriving Wash of the policy maneuvering space he could have had. Vincent Ann, a portfolio manager at Wisdom Fixed Income, bluntly stated that Wash originally hoped to have the option to cut rates on his first day in office, but the bond market had taken that option off the table. Ann characterized this as a typical operation of the "Bond Vigilantes" they are not destroying the Fed's credibility with a sudden rise in yields, but gradually undermining the Fed's policy options by pushing the entire curve above the policy range, bit by bit. Ed Yardeni, a Wall Street veteran and founder of investment consultancy Yardeni Research, issued a worrisome warning on Monday, suggesting that Wash, who was supposed to be sent to the Fed to lower rates, may instead need to push for rate hikes to build credibility. The creator of the term "Bond Vigilantes" pointed out that if the new Fed Chairman fails to signal attention to inflationary pressures as a policy maker, it could trigger further market turmoil, leading to further spikes in government bond yields. In a Monday article, Yardeni wrote, "Wash will preside over the FOMC meeting in June, but who is the true helmsman of Fed monetary policy? We believe it is the Bond Vigilantes." "The bond market is worried that he will tolerate inflation, rather than raise the fed funds rate. He is likely to eventually acquiesce and join the tight camp. Market activists in the bond market will force him to change his stance. FOMC colleagues will do the same." In addition, Yardeni believes that Fed rate hikes may come sooner. He expects the Fed to keep rates unchanged in the June meeting, but a 25 basis point rate hike in July is "highly likely." He also believes that the Fed led by Wash could take the first step towards tightening monetary policy in June - by removing the dovish language from the forward guidance in the post-meeting statement, which had been interpreted as signaling the Fed's next move to cut rates. Yardeni said, "The Fed needs to keep up with the bond market's pace in order to avoid losing control over borrowing costs and reassure bond market investors. Now, they may prefer to see the Fed adopt a tightening policy rather than remain neutral. An unexpectedly hike in the federal funds rate may make them happy!" Yardeni believes that early adoption of a tightening policy by the Fed led by Wash will help alleviate concerns in the bond market, suppress bond yields, and give the Fed greater flexibility later on. He added, "Therefore, if Wash takes a hawkish stance, it may have the opportunity to fulfill the White House's wish - to lower real borrowing costs." "Mortgage rates may fall, corporate financing pressure may ease, and Trump can boast of lowering long-term yields as an economic victory." Just a mirage? Despite the bond market's rush to predict Fed rate hikes, a recent survey shows that most economists expect the Fed to stay flat this year, and believe that the bond market's pricing of rate hikes is a pure overreaction. Since December last year, the federal funds rate has remained in the 3.50%-3.75% range. Now, less than half of economists expect this rate to be lowered this year - a sharp contrast to the situation last month, when more than two-thirds of people expected at least one rate cut. Nevertheless, economists' overall outlook on rate prospects remains mild, with continued belief that inflation caused by energy prices soaring due to the conflict in the Middle East is temporary and unlikely to spread more broadly to other consumer goods prices. In a survey conducted from May 14 to 19 of 101 economists, nearly 85% (83) expect the base rate to remain unchanged at 3.50%-3.75% before the start of the third quarter. In comparison, last month this ratio was just over half, and in March, nearly 70% of people expected at least one rate cut. As for the year-end rate level, economists have not yet reached a clear consensus, but nearly half (49 out of 101) expect no changes this year, which is higher than the previous estimate of about one-third. Nearly one-third of people expect one rate cut this year, with most expecting it in December. Four economists expect at least one rate hike. Regarding the recent rapid rise in bond yields, many strategists have expressed doubts, believing that there is a clear "overreaction" at the moment, with the core question being that trading volume on long-term rate contracts is too thin. Will Conpinolar, a macro strategist at FHN Financial, pointed out that liquidity in long-dated contracts is extremely poor. Taking the example of the May 2026 contract versus the January 2027 contract, the former had a trading volume three times that of the latter this month, and trading in the farther-term contracts had even fewer trades, "This is a low-confidence signal, and the market may simply be hedging against potential rate hike risks." Ryan Swift, Chief U.S. Bond Strategist at BCA Research, also said that the financial markets digest information much faster than the actual evolution of data, sometimes capturing the correct signal ahead of time, but "more often than not, it is an overreaction."