Rate cut expectations 'overkilled'? Federal Reserve officials stabilize expectations, two governors say rate cuts still possible this year

As Middle East conflicts trigger intense market volatility and significant shifts in interest rate expectations, Federal Reserve officials have stepped in to stabilize sentiment. On Friday, two Fed governors made it clear that they still expect rate cuts within the year, indicating that Wall Street’s recent bets on abandoning rate cuts or even hiking rates may be too aggressive.

Fed Governor Waller and Vice Chair for Supervision Bowman both spoke on Friday, after markets had, at one point, almost entirely ruled out any rate cuts before 2026. Meanwhile, another governor, Milan, also supported cutting rates and cast a dissenting vote at this week's policy meeting, advocating for an immediate 25 basis point cut.

Market expectations have reversed sharply in just three weeks. Previously, traders widely expected the Fed to cut rates multiple times, but as Middle East turmoil drove oil prices higher and inflation fears intensified, the market began to discuss a possible rate hike instead.

However, the Fed’s official stance shows no fundamental shift in policy trajectory. The updated dot plot released this week still indicates that all 19 policymakers expect a single rate cut this year. The latest remarks from Waller and Bowman also confirm this outlook.

In an interview, Bowman stated that given the weakening labor market, she expects three rate cuts by the end of 2026. Waller was more cautious but also left room for rate cuts, noting that if the job market continues to weaken, he will again support a rate cut this year.

The recent “hawkish” tilt in market sentiment partially stems from comments by Fed Chair Powell. At this week’s press conference, Powell emphasized the inflationary risks posed by the Iran conflict, discussed the deterioration in the labor market to a much lesser extent, and repeatedly highlighted the high degree of uncertainty in the future policy path. This led the market to interpret the stance as potentially shifting toward tighter policy.

However, employment data is sending a different signal. In February, the U.S. lost 92,000 jobs, and if this trend continues, it would point to a significant labor market slowdown. Some institutions expect the seasonal pattern of weak employment during the spring and summer to reappear, which could push up the unemployment rate and eventually force the Fed to turn toward rate cuts.

In contrast, implementing a rate hike would require several conditions to be met simultaneously, including an unemployment rate that remains below 4.5%, core inflation rising to an annualized rate above 3.2%, and stable policy at the government level. This scenario is more likely to occur in an environment of moderate but sustained oil price increases, but for now, the probability remains limited.