Fed's Hawkish Shift Shakes Markets
At the June FOMC meeting, nine of the 18 officials' dot plots pointed to a rate hike this year, far exceeding market and analyst expectations. Chair Walsh formally removed the "easing bias" language from the post-meeting statement and declined to provide any forward guidance. Reacting to the shock, the swap market quickly brought forward the first rate hike expectation from March 2027 to October this year. The market has now priced in approximately 37 basis points of tightening for the remainder of the year, and the 2-year Treasury yield posted its largest single-day gain since March.
Faced with this hawkish onslaught, Wall Street institutions swiftly changed their positions. In its latest research note, Deutsche Bank formally withdrew its easing forecast, predicting that the Fed will hike once each in September and December for a total of 50 basis points, pushing the rate to 4.1%, and warning that action could come as early as July. Rob Kaplan, Vice Chairman of Goldman Sachs and former Dallas Fed President, warned that if inflation data remain stubborn, the Fed could resume rate hikes as early as fall, and most likely in a series of two to three consecutive moves.
Citigroup Bucks the Trend, Maintains Rate Cut Forecast
The team led by Citigroup's Andrew Hollenhorst maintained a base case diametrically opposite to the market: the next move is a cut, not a hike. The base scenario is a 25-basis-point cut in October, followed by another 25 bps each in December and January 2027. Citi's core thesis is that the sharp drop in oil prices is eliminating the main upside risk to inflation, rising initial jobless claims are replicating the seasonal weakening pattern seen in 2024 and 2025, and core PCE is increasingly appearing as an outlier among various inflation measures.
Logic One: Falling Oil Prices Eliminate Inflation Risks
The first core argument for Citi's rate cut prediction comes from the rapid decline in oil prices. The bank believes that lower oil prices will push down gasoline prices, thereby removing the main source of upward inflationary pressure. Market-based inflation expectations have fallen in tandem with oil prices, with the 10-year breakeven inflation rate dropping to pre-crisis lows. Citi noted that if Fed officials had had more time to digest this latest change in energy prices, the hawkishness of the FOMC meeting would have been significantly reduced.
Logic Two: Labor Market Shows Signs of Weakness
Citi's second core argument focuses on early signals of labor market softening. Initial jobless claims and continuing claims have been trending upward for several weeks. Citi noted that this pattern appeared in both 2024 and 2025, and was followed by a series of weak monthly employment reports and rising unemployment rates. The bank expects initial jobless claims (for the week ended June 20) to remain near 224,000, with continuing claims edging up to 1.813 million, and the four-week moving average to continue to rise. While the absolute level is still not high, a sustained upward trend would be consistent with a gradually weakening labor market.
Logic Three: Core PCE Is an 'Outlier'
The third pillar of Citi's contrarian stance is its questioning of core PCE data itself. May core CPI rose only 0.21% month-over-month, appearing mild. However, Citi estimates that core PCE for May will come in at 0.37% month-over-month, a significant divergence. Citi argues that core PCE's strength is unusual: it is highly influenced by AI-related prices and directly boosted by rising stock prices. The May PPI report showed a 4.8% monthly surge in portfolio management fees, reflecting a rebound in stock prices from early April lows to early May highs, rather than genuine price pressure from consumption. On a cross-sectional basis, the Dallas Fed's trimmed mean PCE, the San Francisco Fed's cyclical PCE, the Cleveland Fed's median PCE, and core CPI all show a milder inflation trajectory than core PCE. Citi expects the gap between core PCE and core CPI to narrow as AI-related prices plateau in the second half of the year.
Wall Street Capitulates: Deutsche Bank and Goldman's Hawkish Stance
In response to Walsh's hawkish impact, Deutsche Bank's chief US economist Matthew Luzzetti and his team said in a research note that the June FOMC outcome removed two key uncertainties: the economic outlook related to the Iran situation and the policy reaction function of new Chair Walsh. Deutsche Bank sharply raised its inflation forecasts, pushing core PCE expectations to 3.2% for end-2026 and 2.5% for end-2027. The bank now expects the Fed to hike once in September and once in December, for a total of 50 basis points, bringing the rate to 4.1%, followed by a hold for all of 2027 and the start of rate cuts in the first half of 2028. Deutsche Bank also flagged hawkish risks: a rate hike could come as early as July, and if the Fed wants to fully reverse the easing effect of last year's consecutive cuts, the total tightening for the year might need to be expanded to 75 basis points.
Goldman Sachs Vice Chairman Rob Kaplan stated clearly that if inflation data does not cool between now and September, a fall rate hike would be a "wise decision." He emphasized that the Fed rarely adjusts policy in isolated one-off moves; rate changes typically come in series of two or three actions. Kaplan, who has experienced multiple monetary policy cycles, based his warning on historical experience, ringing an alarm for the market.