Fed is running out of reasons to cut rates

The Federal Reserve is running out of reasons to cut interest rates. A labour market that refuses to roll over, inflation that is drifting up rather than down, and a widening gap between the FOMC’s dovish statement language and the data on the ground have pushed the central bank’s easing case to its weakest point in the current cycle.

April nonfarm payrolls rose by 115,000, not a boom but enough to confirm the labour market has stabilised after a soft patch in late 2025. March CPI printed at 3.3 per cent year on year. Three regional Fed presidents dissented from the May FOMC statement not because they objected to holding rates at 3.50 to 3.75 per cent, but because the statement’s language was read as tilting toward a cut when the data no longer support one. Goldman Sachs had already pushed its first cut call to December, citing the Iran shock. Others are now abandoning 2026 cuts altogether.

The labour market isn’t forcing their hand

The 115,000 April payrolls figure sits below the 200,000 that characterised the post-pandemic hiring boom, but it is not a recession signal. The unemployment rate has held below 4.2 per cent for 14 consecutive months. Initial jobless claims remain subdued. Wage growth, measured by average hourly earnings, has decelerated to a 3.6 per cent annual pace, consistent with a labour market in equilibrium rather than one deteriorating fast enough to demand monetary relief.

Scott Clemons, chief investment strategist at Brown Brothers Harriman, put it bluntly: “There is nothing in the economy requiring the Fed to lower rates.” That assessment, shared by a growing number of sell-side economists, hinges on a simple observation. Rate cuts are a tool for fighting demand weakness. With consumption holding at roughly 2.5 per cent real growth in the first quarter and payrolls still positive, demand weakness is not the problem. The problem is supply-side inflation that monetary policy cannot fix directly and dare not accommodate.

Inflation’s three-month drift is up, not down

The March CPI reading of 3.3 per cent was not an outlier. The three-month annualised rate on core CPI has edged higher in each of the past three prints. Services inflation, the component the Fed watches most closely because it reflects domestic wage pressures and housing costs, has been sticky above 4 per cent for more than a year. Chicago Fed President Austan Goolsbee, one of the FOMC’s more dovish members, warned in recent remarks that “inflation has been above target for five years and the past three months have shown renewed upward pressure.”

That pressure is not coming from a single source that the Fed can look through. Energy costs are elevated by the Iran conflict and Strait of Hormuz disruption, an externality monetary policy cannot neutralise. Core goods prices have also stopped falling at the pace they did through late 2024 and early 2025, as the disinflationary drag from normalising supply chains exhausts itself. Tariffs layered on by the Trump administration have added roughly 40 basis points to core goods inflation, according to Goldman Sachs estimates, and that effect compounds with each new round.

The upshot is that core PCE, the Fed’s preferred gauge, is tracking above 3 per cent through year-end, according to Barclays. That is 100 basis points above the 2 per cent target and moving in the wrong direction. Boston Fed President Susan Collins warned in early May that the Iran conflict would keep rates elevated into 2027, a timeline that was unthinkable on the FOMC as recently as March.

The sell-side pivot

The shift in rate-cut expectations across Wall Street has been rapid and lopsided. In the span of three weeks, the consensus first-cut call moved from September 2026 to December 2026, and several major houses have dropped their 2026 cut forecasts entirely.

Barclays pivoted on 4 May. It now expects no rate cuts in 2026, with a single 25-basis-point reduction in March 2027. The reason: core PCE above 3 per cent through the end of the year and energy prices that show no sign of mean-reverting. HSBC Private Bank went further, telling clients it expects no cuts in 2026 or 2027, citing persistent inflation, geopolitical risk, and a Fed that has lost the room to ease.

U.S. Bank’s economics research group, which sits closer to the consensus, still pencils in two 25-basis-point cuts, but not until December 2026 and June 2027. On the dovish end of the spectrum, UOB expects a June 2026 start, with a second cut in the third quarter, bringing fed funds to 3.25 per cent by year-end. That is now the outlier.

Lindsay Rosner, head of multi-sector fixed income at Goldman Sachs Asset Management, said the Fed may shift toward “containing upside inflation risks” and could remove its easing bias from the June statement entirely. That language change would be significant. The current statement says the Committee “judges that the risks to achieving its employment and inflation goals are roughly in balance.” Dropping that line, or replacing it with an asymmetric inflation-risk warning, would signal that the next move is more likely up than down.

Internal FOMC friction

The three dissents at the May meeting were not about the rate decision. All 12 voting members supported holding at 3.50 to 3.75 per cent. The objection was to the statement’s forward guidance, which three regional presidents read as implying the next move would probably be a cut. That interpretation, they argued, no longer matches the data.

Dan North, senior economist at Allianz Trade, said the dissent was “the canary in the coal mine.” Recent data, he added, “make it easier for the Fed to hold, and possibly shift its bias toward hikes next year.” The hawkish wing of the FOMC, led by the three dissenting presidents, wants the statement to reflect that the committee is in a holding pattern with no directional bias, or, if a bias must be present, one that leans toward tightening.

This is a structural shift. In 2024 and early 2025, the debate on the FOMC was how fast to cut, not whether to cut at all. By May 2026, the debate is whether the next move is a cut or a hike. The centre of gravity has moved 50 basis points in the hawkish direction without a single rate change.

The Warsh question

Incoming Fed Chair Kevin Warsh, expected to take the gavel when Jerome Powell’s term concludes, has advocated for lower rates and more active use of the balance sheet as a policy tool. His confirmation would normally tilt the FOMC toward an easier stance.

Warsh inherits an inflation picture that makes cutting politically and economically difficult. Cutting rates while CPI is above 3 per cent and core PCE is rising would invite a credibility crisis. The bond market’s reaction function has shifted: the 10-year Treasury yield has repriced roughly 60 basis points higher since January, partly on inflation expectations and partly on the realisation that the Fed is not coming to the rescue. A premature cut could steepen the curve further, tightening financial conditions rather than easing them.

Warsh’s preference for balance-sheet policy may be where he finds room to act. Slowing the pace of quantitative tightening, or ending it outright, would ease financial conditions at the margin without the signal problems of a rate cut. Several FOMC participants have already raised the idea of halting QT by mid-2026, a timeline that predates Warsh’s arrival but aligns with his stated views.

What’s next

The June FOMC meeting, scheduled for 10-11 June, is now the key date. If the statement language shifts from balanced risks to an asymmetric inflation warning, markets will reprice the probability of a 2026 cut from roughly 40 per cent toward zero. The dot plot will also update. The March dots showed a median of one cut in 2026. That projection now looks stale.

The labour market remains the wildcard. If payrolls drop below 50,000 in a single month, or if initial claims spike above 300,000, the calculus shifts. But with unemployment stable, inflation above target, and energy risk structurally higher, the burden of proof has moved. It is no longer on the hawks to justify holding. It is on the doves to explain why a cut is still justified at all.