The high prices of refined oil and the accelerating increase in housing costs make it even more difficult to return inflation to the target of 2%. Economists believe that the Federal Reserve may need to take tougher policy actions, but the larger the interest rate increases, the more caution is warranted regarding the risk of policy mistakes.

Written by: Wu Yu, Jin Ten Data

As the market focuses on whether AI trading can be sustained, investors may also need to be wary of another risk: the Federal Reserve’s excessively tightening policies to curb inflation could become a significant threat to U.S. stocks in 2027.

Neil Dutta, the head of economic research at Renaissance Macro Research, stated in an interview with MarketWatch on Tuesday that the current labor market is strengthening, with a declining unemployment rate, while inflation continues to stray further from the Federal Reserve's 2% target, which significantly raises the risk of excessive policy tightening.

"I do believe that excessive tightening is a major risk," Dutta stated.

Federal Reserve Governor Christopher Waller signaled a potential for further rate hikes during a speech in London on Tuesday. He said if the October CPI data released that day is similar to the previous two months, with a core CPI month-on-month rate reaching 0.3% or higher, the Federal Reserve may need to take tougher policy actions and should consider raising rates by 50 basis points at the December meeting.

The data released afterward indicated that the core CPI month-on-month rate for October was 0.3%. Following the data release, U.S. Treasury yields quickly rose, with the 10-year yield returning to 5%.

Inflation pressures are building again, and rate hikes may exceed market expectations

Dutta believes it remains to be seen whether Waller's stance is supported by other Federal Reserve governors. However, the latest economic data suggest that current rates may still be insufficient to effectively curb rising prices.

Despite a retreat in crude oil prices since the U.S. midterm elections, refined oil prices such as diesel remain high. At the same time, housing costs are beginning to show signs of acceleration, further complicating the decline in inflation.

Dutta pointed out that the October inflation data released on Tuesday indicates that rental housing costs may be accelerating again. If the rise in housing prices cannot slow down, it will be very difficult for the Federal Reserve to pull the overall inflation rate back to the 2% target.

In a report sent to clients on Tuesday, he wrote: "In short, the Federal Reserve remains too optimistic about inflation, and the market is too complacent about the tightening needed to achieve the inflation target."

Treasury yields jump, market re-prices the rate hike path

The bond market has begun to reflect expectations for a tougher monetary policy. According to Dow Jones market data, on Tuesday, the yield on the two-year U.S. Treasury bond — the most sensitive to Federal Reserve rate expectations — rose by 19 basis points to 4.75%, marking the largest single-day increase since April 2025 when Trump announced tariff policies that disrupted global markets.

The widening gap between the two-year Treasury yield and the Federal Reserve's policy rate also reflects that bond investors are signaling to the Federal Reserve: the market expects larger rate hikes in the future.

Currently, investors anticipate that the Federal Reserve will raise rates by a cumulative 50 basis points over the next few months, consistent with the latest forecasts from senior Federal Reserve officials published in September. This means that the 75 basis points "insurance rate cut" implemented by the Federal Reserve in 2025 will be completely reversed.

However, Dutta believes that merely reversing the previous cuts may not be enough. In his report, he wrote, "At this point, reversing last year's insurance rate cuts is only the minimum requirement."