Wolfe Research told clients on Tuesday that the Federal Reserve is unlikely to lift interest rates this summer, even as market pricing has moved toward higher odds of a hike. Analyst Stephanie Roth said the broader economy "should remain solid this year," but that risks to policy rates have moved in a downward direction following recent repricing in markets.
Roth emphasized that inflation is still above the Fed's 2% target, noting "meaningful upside risk to headline and more modest upside risk to core." Despite these inflationary pressures, she argued that the labor market backdrop expected over the summer does not provide sufficient support for a rate increase.
According to the Wolfe note, a mix of seasonal labor market patterns and what the firm describes as the "ongoing impact of AI" will create an appearance of a softer labor market this summer - a dynamic Roth believes will discourage the Fed from moving rates higher. She also assessed bond market pricing as overly hawkish and concluded there is "almost no chance of a hike."
Roth further cautioned that if the conflict in Iran continues for several more weeks, an emergent decline in demand - described as demand destruction - could begin to weigh on economic growth. That development, she warned, would add to labor market softening that Wolfe Research already anticipates.
The firm highlighted a marked shift in market expectations. Current pricing implies roughly a 30% probability of a rate hike by October, down from greater than 80% as recently as yesterday morning, according to the note. Wolfe also documented a change in expectations for the terminal federal funds rate: prior to the conflict, markets expected about a 3.0% terminal rate, compared with about 3.4% at present.
On unemployment, Roth projects the jobless rate to finish the year near current levels, contingent on at least some resolution to the conflict. At the same time, she flagged "upside risk to the unemployment rate over the summer," a factor she said strengthens the case for the Fed to remain patient on policy.
Context and implications
Wolfe Research's view centers on a tension between persistent inflationary readings and labor market developments that may look weaker seasonally and from structural shifts noted in the note. That combination, in the firm's assessment, argues against a summer rate increase despite recent shifts in market pricing.