Two arguments against 2026 Fed rate hikes
Assessing the stance of monetary policy is rarely straightforward, and today’s signals are particularly mixed. A closer look at housing and labor markets suggests there is little urgency for the Fed to raise rates in 2026.
The current stance of US monetary policy is a topic of active debate among economists and investors. Fed Chair Kevin Warsh wisely described it recently as “nuanced.” We outline answers from two different parts of the economy that highlight this very nuanced reality. The housing market says the Fed is tight. The labor market says it is largely neutral. Both suggest there is no urgency for rate hikes. We maintain our view of a Fed on hold through year-end.
Housing pain is real and intense
Both the supply and demand for housing are heavily credit dependent, making housing one of the most interest rate-sensitive sectors of the US economy. Housing starts plummeted in May to the lowest level in 5 years. Housing affordability is historically stretched, and it is pressuring home price appreciation to an extent not usually seen outside recessions (Figure 1).
House price inflation is generally a good leading indicator of future shelter inflation (Figure 2), as is the rental vacancy rate. Since bottoming in 2022, the latter has been steadily trending up and stands at the highest since 2017. This is important because despite intense inflation worries over tariffs and energy prices, shelter disinflation has offered an offsetting valve and is likely to do so for a bit longer. We estimate that shelter rent inflation will slow to 3.2% this year, from 3.7% in 2025.
Housing sector’s message to the Fed: we need a cut, not a hike!
Labor market oddities
According to the latest data, the US labor market is exactly at the assumed full-employment level. The non-observable theoretical non-accelerating inflation rate of unemployment (NAIRU) is believed to be 4.2%, precisely at June’s reported unemployment rate. This would imply that the Fed’s policy stance is exactly where it needs to be. But what if NAIRU is actually lower? This is a valid question worth asking if we are to assess the Fed’s policy stance correctly.
It is often said that NAIRU is determined “experientially.” When unemployment declines so much that it drives up wage inflation, it is a sign that we have dipped below that equilibrium level. But the labor market is supposedly at full employment right now, yet wage inflation has continued to moderate (Figure 3).
One possible interpretation is that NAIRU is actually lower than 4.2%, perhaps because the aging workforce comes with reduced job hopping, or perhaps because AI is reducing worker leverage. Another possibility is that the unemployment rate may yet move higher (the plunge in the prime age labor force participation rate was highly questionable). Either way, the economy is not quite at full employment.
The takeaway from the labor market: there is no urgency for a hike.
The Fed’s next move should be a no move
In a recent speech, Governor Christopher Waller concluded that “we are at a crossroads for policy, and the appropriate action will depend on incoming data.” Data dependency is always a backdrop, but the sensitivity is truly acute at the moment. Every single data release—especially on inflation, but also on the labor market—carries unusual signal weight and is likely to drive more than the usual degree of market volatility as expectations set and reset repeatedly.
Fortunately, the June CPI and PPI inflation prints were quite good (meaning lower than expected), removing urgency for near-term rate hikes. Our expectation remains that the balance of data will lengthen the “on hold” window for the Fed through the end of the year.