BofA rules out rate cuts before second half of 2027 on sticky inflation

Bank of America Global Research no longer expects the Federal Reserve to cut interest rates in 2026, pushing its forecast for the first reduction to the second half of 2027, as core inflation remains stuck at 3.3 per cent and an Iran-driven energy shock reorders the macro landscape.

“We no longer expect the Fed to cut rates this year,” BofA economists wrote in a note published Friday, adding that “core inflation is too high, and moving up.” The revision marks one of the most hawkish call shifts from a major Wall Street research desk since the Fed held rates at 3.5 to 3.75 per cent in December 2025.

The BofA note identified three brakes on easing: the 3.3 per cent core reading, well above the Fed’s 2 per cent target; the energy-price ripple from the Iran conflict, which is feeding through to transport and input costs; and an April payrolls print of 115,000 that more than doubled the 65,000 consensus forecast, a signal the labour market is too tight to need monetary relief.

The energy channel is the wildcard. Brent crude has swung in a $15 range since the Strait of Hormuz disruptions began, and while the US-Iran peace memorandum signed in early May has taken the sharpest edge off the risk premium, shipping insurance costs remain elevated and refinery input prices have yet to fully retreat. BofA’s models treat a sustained $10-a-barrel oil premium as adding roughly 0.3 percentage points to headline inflation over a six-month horizon, enough on its own to keep the Fed sidelined.

Deutsche Bank economists struck a parallel note. “Trend inflation has not shown clear signs of dipping below 3 per cent,” they wrote, adding to the view taking hold across sell-side desks that the Fed’s next move may be no move at all for an extended stretch.

The federal funds rate has sat at 3.5 to 3.75 per cent since the Fed’s December 2025 hold, which followed a cutting cycle that began in September 2024. CME FedWatch now prices less than a 50 per cent probability of a cut before the second half of 2027, matching the BofA timeline.

The hawkish repricing has already shown up in markets. The Fed is running out of reasons to cut rates, as Helena Brandt reported for scramnews on Saturday, with core inflation proving stickier than the Federal Open Market Committee’s December summary of economic projections had assumed.

What BofA’s call changes

BofA had previously pencilled in one or two quarter-point cuts in the second half of 2026. The new baseline removes those entirely and instead sees the fed funds rate staying at 3.5 to 3.75 per cent through to mid-2027, at which point the first 25-basis-point reduction lands.

The revision implies a hold period past 24 months from the last rate change, a duration not seen since the pre-Volcker era. For households, it means mortgage rates, auto loans, and credit card APRs stay elevated. For corporates, refinancing 2024-25 vintage debt gets more expensive the longer the pause runs.

Treasury yields have already begun to reflect the shift. The two-year note, the tenor most sensitive to near-term rate expectations, has edged up roughly 15 basis points over the past week, while the 10-year yield has held above 4.30 per cent. The curve remains inverted but has steepened modestly as the market prices out near-dated cuts while long-end yields stay anchored by slowing growth expectations.

The Fed’s room to manoeuvre

Chicago Fed President Austan Goolsbee and St. Louis Fed President Alberto Musalem have both signalled in recent weeks that cuts are off the table until inflation shows a sustained move toward 2 per cent, though neither has endorsed a 2027 timeline publicly.

The leadership picture adds another variable. Kevin Warsh, President Donald Trump’s nominee to succeed Jerome Powell when the chair’s term ends, has not published a detailed rate framework. But his public writings favour a rules-based approach that would lean hawkish if inflation prints continue above target. The Senate has yet to schedule a confirmation hearing.

What could break the pause early

The BofA note does not rule out cuts arriving sooner if the economy turns. A sharp slowdown in consumer spending, a credit event in commercial real estate, or a rapid de-escalation of the Iran conflict that collapses the energy risk premium could all pull the timeline forward.

BofA also flagged AI-driven productivity gains as a medium-term upside risk to neutral rates, arguing that enterprise adoption of large language models and automation tools could lift trend growth without generating the kind of wage pressure that would normally accompany it. If productivity runs hot, the Fed’s estimate of the neutral rate, already drifting higher in the December dot plot, may need another upward revision, further shrinking the case for cuts.

For now, the base case is a Fed on hold through 2026, with the first cut arriving no earlier than the third quarter of 2027. Gundlach urged a 20 per cent cash and 20 per cent commodities allocation on Saturday, a portfolio posture that fits a world in which the central bank does not ride to the rescue.