Wall Street collectively "turns hawkish"; under the dual pressure of strong employment and high inflation, Goldman Sachs and Bank of America have successively pushed back expectations for the Federal Reserve to cut interest rates to the end of 2026 or even 2027, with some traders even betting on rate hikes in 2027.

Written by: Zhao Ying

Source: Wall Street Journal

Strong employment data and persistent inflationary pressures are driving major institutions on Wall Street to collectively delay their expectations for interest rate cuts by the Federal Reserve, with some institutions even pushing back the timing of the first rate cut to 2027.

Goldman Sachs and Bank of America both adjusted their forecasts last week, postponing the timing of the Federal Reserve's next rate cut from September this year to a later date.

Meanwhile, market traders are increasing their bets that the Federal Reserve will maintain interest rates unchanged throughout 2026 and expect a possibility of rate hikes in early 2027. Hawkish signals have also emerged within the Federal Reserve—during the last central bank meeting, two officials expressed dissenting views, believing the next move may be a rate hike rather than a cut.

The impact of the Iran war on the oil market has raised inflation expectations, further compressing the space for monetary easing. As a result, U.S. Treasury prices fell on Monday, yields rose, and the two-year Treasury yield, sensitive to monetary policy, increased by more than 6 basis points to 3.95%. U.S. stocks rose slightly, and the dollar index also strengthened somewhat.

Employment Data Becomes "The Last Straw That Broke the Camel's Back"

Aditya Bhave, head of U.S. Economic Research at Bank of America, wrote in a report on May 8: "The data does not support a rate cut this year. Core inflation is too high and still rising. The strong performance in the April employment report has become the last straw that broke the camel's back, especially against the backdrop of continuous hawkish signals from Federal Reserve officials."

Bhave and his team now expect the Federal Reserve's next rate cut to be delayed until July 2027, a significant postponement from the previously predicted September this year. Bank of America rate strategists also pointed out to clients in another report that traders' pricing of rate hike risks by the Federal Reserve is "clearly insufficient" and suggested shorting two-year Treasuries, betting that short-end yields will underperform the long-end.

The April non-farm employment report showed that U.S. employers added jobs for the second consecutive month above expectations, indicating that the job market remains robust even amid ongoing conflicts in the Middle East.

Goldman Sachs Follows Up, Several Major Banks Form a Coalition

The team led by Jan Hatzius at Goldman Sachs also pushed back its forecast for the Federal Reserve's next rate cut from September this year to December 2026 after the employment data was released, while also lowering the probability of the U.S. economy falling into recession over the next 12 months.

Previously, Morgan Stanley and Barclays had predicted that the Federal Reserve would maintain a prolonged pause. Matt Hornbach, global macro strategy chief at Morgan Stanley, stated in an interview with Bloomberg on Monday: "This month’s inflation report will certainly be trickier. Oil prices are fluctuating significantly every day, which will have a major impact on the inflation trend before the end of the year."

Bloomberg macro strategist Simon White also noted that rising inflation has become a consensus in the market, but the upcoming discussions will focus on how long high inflation will persist, whether there will be second-round effects, and the ultimate extent of central bank rate hikes.

Some Institutions Still Insist on Rate Cuts This Year

Not all Wall Street institutions have turned hawkish. Economists Andrew Hollenhorst, Veronica Clark, and Gisela Young from Citigroup still believe that the Federal Reserve will cut rates before the end of the year. Their reasoning is that job growth and wage growth have both been tepid in recent months, and the market's pricing for easing policies is, instead, relatively low.

The market is currently closely watching this week's inflation data. According to a Bloomberg survey, economists expect that the year-on-year increase of the April CPI, to be released on Tuesday, will rise from 3.3% last month to 3.7%; core CPI, excluding food and energy, is expected to increase by 2.7% year-on-year. PPI data will be released on Wednesday, providing the market with a more complete picture of inflation.