Next Fed rate hike?

Forward indicators project persistent inflation in core services ex-housing. Raw research output suggests a persistent and potentially re-accelerating inflationary impulse in core services ex-housing for Q1 and Q2 2026. The ISM Services Prices Paid Index reached 66.6 in January 2026, marking its 14th consecutive month above the highly inflationary 60.0 threshold and showing a 10.26% year-over-year increase from January 2025 ^{[^]}. This widespread pressure, with 17 of 18 industries reporting price increases, indicates entrenched cost pressures stemming from tariffs, contract renewals, and geopolitical factors ^{[^]}. Furthermore, sticky wage growth and uncertain productivity gains are anticipated to sustain Unit Labor Cost (ULC) growth at a rate that exerts upward pressure on services inflation, supporting a projection of supercore PCE inflation remaining well above the Fed's 2% target ^{[^]}.

Markets may underprice risk of a hawkish policy pivot. Historically, hawkish FOMC dissents in the 2010s were largely theoretical, driven by fears of future inflation or financial instability from accommodative policy, even when core inflation consistently remained below target ^{[^]}. However, the projected conditions for Q1-Q2 2026 present a dramatically different landscape, with core inflation anticipated to be persistently above target, a tight labor market, and strong inflationary signals from ISM Services Prices and ULCs ^{[^]}. This suggests that the justification for a hawkish stance is now based on realized data and clear forward momentum, implying the threshold for a hawkish dissent should be substantially lower today as risks are manifest rather than abstract ^{[^]}. Prediction markets currently appear to underprice the risk of a hawkish pivot, including a potential rate hike, in Q2 2026, largely relying on a 'last mile' disinflation narrative. Nevertheless, the reacceleration in the ISM Services Prices Paid index and persistent Unit Labor Cost growth directly challenge this view, suggesting that markets may be over-reliant on headline inflation trends ^{[^]}. A continued high ISM Services Prices Paid index in upcoming reports, coupled with hot monthly prints for core services ex-housing inflation, would necessitate a market re-evaluation. Moreover, a hawkish dissent at upcoming FOMC meetings would serve as a powerful signal, indicating a shift in internal debate and likely leading to a repricing of Fed policy towards a more restrictive stance ^{[^]}.

Kevin Warsh's Fed Chair nomination faces significant bipartisan Senate opposition. Kevin Warsh's nomination for Federal Reserve Chair, formally made on January 30, 2026, is currently stalled in the Senate Banking Committee due to significant bipartisan opposition ^{[^]}. Republican Senator Thom Tillis (R-NC) has pledged to block the nomination until the Department of Justice (DOJ) concludes its criminal investigation into current Chairman Jerome Powell ^{[^]}. Concurrently, all eleven Democratic members of the Senate Banking Committee have formally requested a delay, citing ongoing DOJ probes into Chairman Powell and Governor Lisa Cook, alongside concerns regarding potential "loyalty pledges" by Warsh to President Trump ^{[^]}. With the committee's composition of 13 Republicans and 11 Democrats, the nomination can be prevented from advancing by a single Republican defection combined with unified Democratic opposition ^{[^]}.

This stalemate extends Chairman Powell's tenure, creating policy uncertainty. This procedural stalemate has significant consequences, primarily extending Chairman Jerome Powell's leadership indefinitely beyond his scheduled term expiration in mid-May 2026, as he legally remains until a successor is confirmed ^{[^]}. This prolonged leadership introduces profound policy ambiguity at the Federal Reserve, directly impacting financial prediction markets. These markets, particularly those focused on the timing of future interest rate decisions, must now price in various scenarios, including a continued Powell tenure under investigation or an eventual Warsh confirmation with potentially different policy leanings ^{[^]}. Such uncertainty regarding the decision-maker heavily influences the timing of policy changes, leading to increased volatility ^{[^]}.

Wage growth for non-supervisory employees remains robust, exceeding key inflation metrics. Average Hourly Earnings (AHE) for production and non-supervisory employees rose 3.7% year-over-year in January 2026 ^{[^]}, significantly surpassing the Federal Reserve's 2% inflation target. This rate also outpaces the broader Employment Cost Index (ECI) for private industry wages, which increased by 3.3% over 12 months in Q4 2025 ^{[^]}. Further highlighting this elevated and steady pace of wage gains in this critical labor market segment, the persistent 3-month/3-month annualized run rate for AHE stood at 3.5% as of January 2026 ^{[^]}.

Strong wage growth in this segment carries significant inflationary risk. These lower-income households typically have a higher marginal propensity to consume, meaning a larger portion of their wage increases is spent, directly fueling aggregate demand. Such concentrated wage pressures, particularly in sectors with inelastic demand, elevate the risk of a wage-price spiral. In this scenario, increased labor costs are passed directly to consumers as higher prices, further justifying subsequent wage demands.

Diverging wage trends create a complex policy dilemma for the Fed. While broader labor market indicators suggest some cooling, the resilience and re-acceleration of wages in the non-supervisory segment present a powerful counter-narrative. This divergence, particularly the persistent gap where non-supervisory AHE growth (3.7% ^{[^]}) exceeds the overall ECI (3.3% ^{[^]}), indicates that wage gains are currently skewed towards lower earners. This dynamic carries a more potent inflationary impulse and is a key variable for the Fed's future monetary policy decisions.

Oil markets currently price a significant risk of crude exceeding $100. The oil market estimates a 17.9% chance (nearly 1-in-5.6) that WTI crude oil will surpass $100 per barrel within the next year. This substantial tail risk is driven by escalating geopolitical tensions, particularly the potential for a major disruption at critical chokepoints like the Strait of Hormuz, which could spike prices into the $91-$108 per barrel range ^{[^]}. While OPEC+ has maintained production discipline, pausing output increases through Q1 2026 ^{[^]}, and demand forecasts remain divergent ^{[^]}, these factors create a fragile market equilibrium where a supply shock could have a profound impact.

A prolonged oil shock could force a defensive Fed rate hike. A sustained oil price shock above $100 per barrel, especially amidst an otherwise stable macroeconomic environment, would present a significant stagflationary dilemma for the Federal Reserve. Faced with rising headline and potentially core inflation, the Fed would be under immense pressure to execute a defensive rate hike to safeguard its anti-inflation credibility, even if it risks dampening economic growth. The analysis suggests that if the broader prediction market implies only a 25% chance of a Fed hike within the next year, it may be significantly underpricing the impact of an oil shock, as this specific scenario alone contributes an estimated 12.5% to that overall probability.

Reintroducing hawkish language signals active consideration for a 2026 hike. The Federal Reserve's December 10, 2025 Summary of Economic Projections (SEP) indicates a median federal funds rate of 3.4% for year-end 2026, implying one 25-basis-point rate cut from the current target range ^{[^]}. However, the January 28, 2026 FOMC statement notably omitted explicit language regarding "upside risks to inflation," despite Chair Powell acknowledging these risks "still exist" but are "diminished" ^{[^]}. To credibly signal active consideration of a 2026 rate hike, the FOMC would need to reintroduce explicit hawkish language into its official statements. This would involve re-inserting phrases such as "upside risks to inflation remain elevated" into FOMC communications, moving beyond the current assessment of "diminished but extant" risks ^{[^]}.

A significant upward shift in the 2026 dot plot is essential. Alongside this verbal shift, the March 17-18, 2026 SEP dot plot would need to materially revise its median 2026 projection upwards by at least 50 basis points, moving from 3.4% to 3.9% ^{[^]}. This quantitative adjustment would first require eliminating the expectation of a cut by moving the median 2026 dot to 3.6%, signaling a "hawkish hold," and then further to 3.9% to indicate active consideration of a 25-basis-point hike by year-end 2026 ^{[^]}. Such a shift would likely be accompanied by an upward revision of the median 2026 core Personal Consumption Expenditures (PCE) inflation projection to 2.8% or higher ^{[^]}. Financial markets, which currently anticipate rate cuts in 2026 consistent with the December SEP, would begin pricing in a hike if faced with upside inflation surprises and resilient labor market data, eventually compelling the Fed to align its communications with market expectations ^{[^]}.

The outcome of a potential Federal Reserve rate hike by January 1, 2028, is largely dependent on the Fed's management of its dual mandate: ensuring price stability and maximum employment. As of February 2026, the Fed maintained interest rates at 3.5%-3.75% following three rate cuts in late 2025. Inflation has moderated, with CPI at 2.4% and core inflation at 2.5% in January 2026, while the unemployment rate stood at 4.4% in December 2025 ^{[^]}.

Factors that would increase the probability of a rate hike include persistent or reaccelerating inflation, particularly if the Personal Consumption Expenditures (PCE) price index consistently exceeds the 2% target or reaches 3-4%. Robust and sustained economic growth, surpassing 2.5-3% annually, combined with a tightening labor market characterized by unemployment dropping below 4% and accelerating wage growth, would signal an overheating economy. Further catalysts could involve hawkish Federal Reserve communication, significant new fiscal stimulus, or unforeseen supply shocks that drive up commodity prices ^{[^]}.

Conversely, a sustained period of disinflation or deflation, where inflation falls to or below the 2% target, would make a rate hike improbable. A significant economic slowdown or recession, marked by near zero or negative GDP growth, or a weakening labor market with unemployment rising above 5-5.5% and declining wage growth, would also deter tightening. Dovish Federal Reserve communication or emerging financial instability could also lead the Fed to avoid rate increases. Key dates to watch include monthly CPI, PCE, and employment reports, quarterly GDP reports, and especially the FOMC meetings in March, June, September, and December of 2026 and 2027, which include the Summary of Economic Projections (SEP) ^{[^]}.