Federal Reserve preview: A pause before a December hike

We will have two jobs reports and one inflation print ahead of the December decision. The November CPI will be released the day after the Fed meeting, and officials will almost certainly get to see it. As such, they will have more information than the market does, meaning a surprise can’t be completely ruled out.

We are forecasting a 25bp rate hike at the December meeting (leaving the Fed funds target rate range at 4-4.25%) followed by a prolonged pause through to December 2027, when we have that December 2026 hike being reversed. This is in line with the current consensus forecast, while the Fed’s own projections (its central forecast) see one hike this year with rates left unchanged throughout 2027.

While the sharp move higher in Treasury yields and the firmer dollar are tightening financial conditions to a degree, our forecast path for the Fed assumes that in the couple of months following the midterm elections we see an agreement that improves the flow of energy from the Persian Gulf, but significantly, also allows for a sharp reduction in shipping and insurance costs. It’s the latter point that is crucial to delivering lower pump prices at a time when refineries are working at capacity. If correct, this should meaningfully ease inflation pressures, and with US wage growth (the biggest cost input for corporate America) looking very benign at just 3% and the largest component of the inflation basket – housing at 35% by weight – set to experience more disinflation, we believe overall US inflation can fall back to 2% in the second half of 2027.

The risk to our view is clearly tilted towards a longer-lasting conflict rather than one that is resolved imminently. This means we would not rule out additional hike(s) in 1Q 2027, but with households experiencing a greater squeeze on spending power (weak wage growth amid rising energy costs) and bond yields likely pushing even higher – leading to new cycle highs for mortgage rates and corporate borrowing costs – the risks of a weaker economy will increase. As such, in this more stressed economic scenario, eventual cuts to policy rates will likely be swifter and more substantial in 2H 2027 than in our base case.