John Velis at BNY Markets argues that current US inflation is being driven by non-rate-sensitive components of core PCE, limiting how effective further Federal Reserve tightening can be. He expects one more rate hike in December 2026 but questions whether all the hikes priced for 2027 will be delivered, given the nature of the inflation shock and potential demand destruction.

Policy hikes face structural inflation limits

“We expect the Fed to raise rates once more for 2026 at the December meeting. Into 2027, we’re less sure whether the Fed can proceed with as many hikes as the market has priced in. The answer hinges on how effective tighter policy can be given the current inflation shock.”

“If tightening serves to cool demand without affecting those prices that are key contributors to current services inflation, we may see the Fed have to relent next year.”

“This isn’t to say we disagree with the move to increase rates, nor the expectation that they’ll continue to rise somewhat. Our point is that the current policy regime is more about preserving credibility and the Fed’s inflation-fighting bona fides than about rate actions that will, by themselves, crimp inflation, unless demand is similarly restrained.”

“For now, we understand the market’s hawkish pricing, but we’re watching for the unintended consequences that could change the outlook.”

“Even if we were to see some welcome relief on energy prices, a positive supply shock relative to the status quo – and the economy reacting accordingly – doesn’t mean traditional demand-driven inflation can be ruled out.”