Why this strategist still thinks there will be 4 Fed rate cuts in 2026

Federal Reserve Policy Outlook & Economic Data Analysis

Key Concepts:

• Federal Funds Rate: The target rate that the Federal Reserve sets for commercial banks to lend reserves to each other overnight.
• Quantitative Tightening (QT): A contractionary monetary policy where a central bank reduces the amount of liquidity in the money supply by selling assets.
• FOMC: Federal Open Market Committee, the body within the Federal Reserve System that sets monetary policy.
• Dual Mandate: The Federal Reserve’s goal of achieving maximum employment and stable prices.
• Disinflation: A decrease in the rate of inflation.
• Employment Cost Index (ECI): A quarterly report measuring the change in the costs of labor.
• GDP Tracker: Models used to estimate current Gross Domestic Product. (e.g., Atlanta Fed GDPNow)
• Trueflation: An alternative measure of inflation that utilizes real-time data.

I. Fed Officials Signal Rate Hold & Inflation Concerns

The discussion centers around recent statements from Federal Reserve officials, specifically Beth Hammock (Cleveland Fed President) and Lorie Logan (Dallas Fed President), indicating a preference for maintaining current interest rates. Both officials expressed concerns about persistent inflation, despite recent rate cuts. Hammock stated monetary policy is “in a good place to maintain rates at current levels” and anticipates a potential “hold for some time,” citing a risk of inflation remaining around 3% this year. Logan echoed these sentiments, noting uncertainty about how restrictive current policy is and emphasizing the need to see inflation demonstrably falling before considering further cuts. She stated, “After last year’s rate cuts, it is uncertain how restrictive policy currently is.” Both officials prioritize assessing the impact of previous rate cuts and the stability of the job market.

II. Labor Market Cooling & Wage Disinflation

Danielle DiMartino Booth argues that the Fed officials’ statements appear disconnected from recent labor market data. She highlights several indicators pointing to a cooling labor market:

• Layoffs: January saw the highest number of layoffs since 2009, according to Challenger, Gray & Christmas.
• Hiring: January also experienced the lowest hiring numbers since 2009, as reported by ADP, Indeed, and Link Up.
• Employment Cost Index (ECI): The ECI printed at its lowest rate since 2021, indicating cooling wage inflation. This is described as Federal Reserve Chair Powell’s “favorite gauge of wage inflation.”
• Demand for Labor: DiMartino Booth asserts that the decline in wage growth is not a supply issue, but rather a result of decreasing demand for labor in the cyclical private sector.

This data suggests a weakening labor market that, according to DiMartino Booth, the Fed officials are overlooking, potentially due to political considerations.

III. GDP & Economic Data Revisions

The conversation touches upon the complexities of GDP measurement and potential revisions. Ben Herszon, the creator of the Atlanta Fed GDP tracker, revised his Q4 GDP estimate down to 2.5% and Q1 to 2.3%. The discussion emphasizes that GDP models are dependent on their construction and that annual benchmark revisions to payrolls, expected to be significant, will likely result in income being backed out of GDP figures. This process delays accurate recession dating in the US. The point is made that the Atlanta Fed’s high GDP numbers should be viewed cautiously.

IV. Future Rate Cut Projections & Potential Leadership Transition

DiMartino Booth’s base case projection is for four interest rate cuts in 2026. She suggests that if the Fed doesn’t cut rates at the March or April FOMC meetings, the incoming Fed Chair, likely Kevin Warsh, may need to implement larger cuts to “play catchup” for the Fed’s inaction in the face of a weakening labor market.

V. Kevin Warsh as Potential Fed Chair & Market Preferences

The discussion shifts to the potential appointment of Kevin Warsh as the next Fed Chair. While acknowledging his strong qualifications and experience (including guiding Ben Bernanke during the 2008 financial crisis), DiMartino Booth notes his advocacy for quantitative tightening (QT), which is unpopular with market participants. She also points out that Jay Powell initially held similar resolute views but was forced to adjust course during market turbulence in 2018. Some investors reportedly preferred Rick Reer of BlackRock, citing his deep understanding of financial markets. However, DiMartino Booth emphasizes Warsh’s own extensive financial market knowledge gained at Morgan Stanley.

VI. Consumer Spending & Retail Sales Data

Recent retail sales data came in softer than expected, with a negative revision to November figures and a negative print for December (to the second decimal point). This is linked back to slowing wage growth, suggesting limited consumer spending capacity. New York Fed delinquency data further supports the idea that the US consumer is struggling, particularly outside the top 10% income bracket. The question is posed: “How are you going to squeeze blood out of a rock?” referring to the difficulty of maintaining consumption growth with limited wage increases.

VII. Inflation Measurement & Alternative Indicators

The conversation highlights the use of alternative inflation measures like Trueflation, which has gained traction on the Bloomberg terminal. As of the morning of the discussion, Trueflation’s headline inflation rate was 7.4%, with core inflation at 1.15%, indicating disinflation in services and declining rents.

Conclusion:

The discussion paints a picture of a potentially cooling economy, with a weakening labor market and slowing wage growth. Despite this, some Fed officials remain focused on persistent inflation and hesitant to cut rates. The appointment of Kevin Warsh as the next Fed Chair could signal a shift towards a more hawkish monetary policy, but market turbulence could force adjustments. The data suggests a need for careful monitoring of economic indicators and a nuanced approach to monetary policy, balancing the risks of inflation and recession. The overall takeaway is that the path forward for the Federal Reserve is uncertain and dependent on incoming data and potential leadership changes.