The US Federal Reserve is likely to keep interest rates on hold through 2026 as inflationary pressures intensify, driven by geopolitical tensions and elevated energy prices, according to a research report by Elara Securities (India).
The report highlights that the ongoing US–Iran conflict has added incremental inflationary pressure to the US economy, pushing price trajectories further away from the Federal Reserve’s 2 per cent target. Analysts now expect the central bank to abandon its earlier easing bias and maintain a steady rate stance through the year.
Elara has withdrawn its earlier forecast of three rate cuts totalling 75 basis points in 2026, citing persistent upside risks to inflation that outweigh concerns around labour market softness. Inflation is projected to remain elevated, with core Personal Consumption Expenditure (PCE) revised upwards to 2.9 per cent and headline PCE expected in the range of 3.0–3.5 per cent.
The brokerage also assigns a 20 per cent probability of a rate hike later in the year, particularly if the Strait of Hormuz disruption persists, triggering further spikes in energy prices and exacerbating supply chain bottlenecks.
Inflation Risks Dominate Policy Outlook
According to the report, inflation risks have decisively overtaken labour market concerns in shaping monetary policy. Model estimates suggest that inflation is likely to remain in the 2.7–3.5 per cent range, significantly above the Fed’s target, with rising inflation expectations amplifying upside risks.
Energy prices remain a key driver, with crude oil hovering around USD 100 per barrel and gasoline prices significantly higher than pre-war levels. Tariffs and supply chain disruptions are further contributing to persistent price pressures.
The report also warns of a potential wage-price spiral, as widening wage gaps between job switchers and stayers could push employers to raise compensation, sustaining inflationary momentum.
Labour Market Remains Resilient
Despite inflation concerns, the US labour market is expected to remain relatively stable. Elara estimates the unemployment rate at around 4.6 per cent for 2026, with gradual softening rather than a sharp deterioration.
Recent data indicate improving hiring sentiment and a recovery in private payrolls, alongside a decline in widespread layoffs compared to 2025 levels. Lower immigration has also reduced the break-even employment threshold, allowing the labour market to remain balanced despite slower job creation.
Growth Outlook Stable but Secondary
On the growth front, risks are viewed as moderate and unlikely to influence policy decisions in the near term. Elara maintains a US GDP growth forecast of around 2.2 per cent for 2026, noting that any slowdown from higher energy prices or supply disruptions would materialise with a lag.
Interestingly, the report points out that the geopolitical environment could also offer limited upside through increased US energy exports, partially offsetting the negative impact on consumption and business investment.
Policy Shift Towards Hawkish Bias
Given persistent inflation above target for several years, the Federal Reserve is expected to gradually shift towards a more hawkish stance, showing greater tolerance for a softer labour market while prioritising price stability.
Elara notes that any attempt to push for rate cuts prematurely could risk a spike in US Treasury yields, tightening financial conditions further and complicating the policy outlook.
Overall, the report underscores a clear pivot in global monetary dynamics, where inflation persistence—fuelled by geopolitical disruptions and structural factors—remains the dominant concern, shaping the Federal Reserve’s cautious and potentially restrictive policy stance through 2026. |
