Dovish leaders turn hawkish, Federal Reserve officials hint "rate cuts may be over," but "the probability of a rate hike is low."

Subtle yet profound shifts are taking place within the Federal Reserve’s internal stance. Against the backdrop of the Iran war driving up oil prices and reigniting inflationary pressures, several officials previously regarded as doves—such as Goolsbee and Daly—have begun sending hawkish signals, hinting that the Fed’s rate-cutting cycle, which began in September 2024, may have reached its end.

Recent developments show that Chicago Fed President Austan Goolsbee has become one of the first officials to explicitly mention the possibility of raising rates. He stated that if inflation performs well, the Fed may still return to multiple rate cuts this year, but also acknowledged that "there are scenarios where rate hikes may be necessary." San Francisco Fed President Daly, known for her dovish stance, emphasized that there is no single most likely path for interest rates.

Meanwhile, another major logic supporting the hawkish position is that more officials believe the current rates are close to or have reached the neutral level. Fed Vice Chair Philip Jefferson said that recent rate cuts "have roughly placed rates in the neutral range".

This shift in stance is directly impacting the market. Since the outbreak of the Iran war, long-term yields have surged, traders have shifted their expectations for future rates upward, and have modestly priced in the potential for rate hikes this year. This change in expectations is quickly transmitted to the real economy through bond yields, making businesses and households face higher mortgage rates and other financing costs.

Analysts note that while rate hikes remain a low-probability event, the mere fact that the possibility is discussed publicly signals an important shift in the Fed’s policy balance.

Dovish Officials Turn Hawkish in Unison, Policy Signals Tighten

The notable aspect of this shift is that hawkish voices now mainly come from officials previously considered neutral or even dovish.

Fed Governor Christopher Waller was previously one of the strongest advocates for rate cuts, but he stated this month that inflation risks from the Iran war led him to support holding rates steady at the March meeting.

Fed Governor Lisa Cook noted that the Iran war has pushed up energy prices, and persistently high inflation has once again become the primary risk confronting the Fed.

Recently, San Francisco Fed President Mary Daly, well-known for her dovish stance, wrote that the Fed’s March dot plot carries a risk of conveying false certainty about the rate path, and stressed there is no single most likely path for interest rates.

Fed Chair Jerome Powell himself also downplayed the reference value of the dot plot during a press conference this month, saying, “Now more than ever, forecasts should be treated with caution.”

The Fed’s March dot plot median forecast still indicates one rate cut this year. But the statements made by these officials show that confidence in this projection is weakening, and market interpretations have become increasingly cautious.

Another major logic supporting the hawkish stance is that more officials believe current rates are close to or have reached the neutral level.

Since September 2024, the Fed’s rate target has fallen by nearly 2 percentage points, currently ranging from 3.5% to 3.75%.

Recently, Fed Vice Chair Philip Jefferson said that recent rate cuts "have roughly placed rates in the neutral range". Richmond Fed President Thomas Barkin said last Friday (March 27) that rate cuts have put the federal funds rate at the upper end of the neutral range.

If rates are indeed at neutral, further cuts would mean substantial easing. As inflation has not yet fallen back to the 2% target, this would carry the risk of fueling inflation. Deutsche Bank Chief U.S. Economist Matthew Luzzetti said:

Because the Iran war has exacerbated the Fed’s inflation anxiety, the Fed currently has almost no reason to correct the market’s hawkish pricing. The new market expectation for stable or even rising rates is actually aligning with the Fed’s policy intentions.

Six Years of Persistently High Inflation Increases Pressure on Expectations Management

The stubbornness of inflation is the deep-seated reason behind the Fed’s tightening stance. Measured by the Fed’s preferred core indicator, the current inflation rate is about 3%, and has exceeded the 2% policy target for six consecutive years.

Officials worry that if the public forms a long-term high inflation expectation, this expectation will become self-fulfilling, and simply waiting for tariff shocks or falling oil prices will not suffice to bring inflation back to target.

Derek Tang, an analyst at Monetary Policy Analytics, pointed out that Fed officials "really do not want to see inflation expectations rise," but the problem is "they are not clear how close they are to the critical point."

The Iran war further exacerbates this risk. Rising oil and food prices directly affect consumers’ daily experience, making it easier to push up short-term inflation expectations.

However, there is currently no evidence that expectations have risen systematically—the University of Michigan’s March consumer survey shows short-term inflation expectations have increased somewhat, but long-term expectations remain moderate.

Still, despite more hawkish signals, some economists believe rate cuts this year are not out of the question. A weak labor market provides some basis for cutting: Nonfarm employment in February fell by more than 90,000, and the unemployment rate rose to 4.4%.

Natixis Chief U.S. Economist Christopher Hodge said, "The economy lacked strong momentum in early 2024," and he still expects further rate cuts this year.

Moreover, if tensions in the Middle East ease, oil prices could drop from their current highs, and inflation could gradually return to the 2% target. If soaring oil prices further suppress consumption and employment, the Fed may be forced to cut rates to prevent recession.

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