Fed On Hold

Don’t Just Do Something, Stand There! The Case for a Fed on Hold Jamie Patton Nick Verdi Managing Director Managing Director Co-Head of Global Rates, Fixed Income Fixed Income

Fixed Income | Don’t Just Do Something, Stand There! The Case for a Fed on Hold August 2026

Patience Is a Policy Today’s Inflation Is Supply-Driven, Not the Inflation remains annoying, but decelerating. Inflation Demand-Driven Inflation That Policy Rates expectations are well anchored. And labor markets are Can Effectively Impact cooling. The burden of proof for another hike should be The usual rationale that raising rates prevents evidence that inflation is broadening, reaccelerating or macroeconomic overheating by bringing demand in line that policy is no longer restrictive. None of those boxes with supply is really not even relevant today with inflation are checked today. driven by supply shocks, tariffs, and the commodity-like shock of AI needs. The Fed can’t produce more oil or The greatest challenge for the Fed-on-hold thesis is housing. And the Fed can’t reduce tariffs. Which begs the that the U.S. economy may be experiencing an unusual important question of whether rate hikes would even help combination of forces that do not fit neatly into traditional moderate today’s inflation. cycles. Large fiscal deficits and an AI capex boom are simultaneously supporting demand and potentially raising the economy’s productive capacity. If AI-driven Attempting to Lower Inflation Via Resource productivity gains arrive only gradually, while fiscal and Utilization Is a Losing Strategy private investment spending remain robust, growth A key lesson of recent years is that the effects of supply could stay above trend for longer than expected. In shocks on inflation are often large, while the effects of that environment, inflation may prove stickier than changes in resource utilization are moderate. To put conventional models suggest, and the neutral policy things in perspective, the impact of a 1% increase in the rate may be higher than assumed. However: unemployment rate on inflation averages 15-20 basis points (bp) in Personal Consumption Expenditure (PCE) Policy Is Already Restrictive terms and 30-35 bp in Consumer Price Index (CPI) terms (the impact is larger in the shelter category, which has a The current Fed Funds target rate of 3.50-3.75% is well much higher weight in the CPI). So it would take SEVERAL above the Fed’s own estimate of neutral rates (3%). percentage points of rising unemployment to fully offset Housing affordability is near historic lows. Businesses and the effects of tariffs and the Iran war which are estimated households are refinancing into much higher rates than to have boosted inflation by 80 bp and 40 bp respectively. existed in years prior. The economy is not experiencing In other words, unemployment would have to rise by 4% to macroeconomic overheating, the strongest rationale for 6% to offset the supply side shocks to inflation. Significantly raising rates. higher unemployment is certainly not something Fed Chair Warsh would be excited about. Labor Markets and Growth Are Already Cooling Job openings have declined from their peaks. Wage growth has moderated. Real wages are teetering between flat and Janet Yellen talked about exactly this in her negative. Productivity is quietly running at its strongest remarks at the Hutchins Center “The Powell years pace in years, helping absorb wage growth before it at the Fed: A retrospective,” on June 2, 2026: becomes inflation. Hiring is slowing with the 3-month moving average of Nonfarm Payroll growth falling from “Monetary policy cannot tame supply-driven 142k in May to 77k in June to just 20k in July. Real GDP has inflation without exacting unacceptable slowed this year from 2.1% in Q1 to 1.5% in Q2. And fiscal unemployment costs.” Those steep costs, she support is fading. The Fed doesn’t need to engage the added, lie behind the standard central bank speed brakes when the airplane is already on glideslope. wisdom that “Looking through supply shocks should remain the default strategy unless inflation expectations are at genuine risk of becoming unanchored.”