For months, futures markets have priced in just two quarter-percentage-point cuts this year from the Federal Reserve.
Such rate cuts are enormously important to investors and financial markets because they almost inevitably give stocks a boost, as expectations of easier borrowing create optimism that companies can both reduce their interest expenses and borrow more to expand, while more favorable financing for consumers should boost their spending.
Yet, despite menacing pressure from the White House in recent months to lower the target interest rate dramatically, Fed Chair Jerome Powell has remained steadfast in his commitment to let the economic data -- on jobs and inflation, in particular -- determine how the Fed sets monetary policy. As a result, in January the U.S. central bank did not cut the target rate at all, much to President Donald Trump's consternation.
Suddenly, however, it's beginning to look like the Fed could cut its target rate more than twice this year, which would be an extremely welcome development on Wall Street.
Inflation is falling slightly faster than expected
The Fed has been waiting for inflation to close in on its 2% target, but overall price growth has remained stubbornly above that level for months.
Image source: Getty Images.
Now, however, inflation seems to be falling more quickly than expected. Consumer prices rose 2.4% (on an annual basis) in January, while economists had expected them to rise 2.5%. Taking out volatile food and energy prices, the Consumer Price Index was up 2.5%, the lowest level since April 2021.
If that trend toward 2% continues, it suggests the Fed will have room for a third or even a fourth quarter-percentage-point cut this year. Even some Fed officials, who are generally very cautious about predicting rates, are voicing that possibility. Federal Reserve Bank of Chicago President Austan Goolsbee recently said that if the path to 2% continues, "I still think there's several more rate cuts that can happen in 2026."
And tariff-related price increases -- so far at least -- have been modest, mostly confined to some goods categories. In addition, Powell's term as Fed chief ends in mid-May, when he likely will be replaced by Trump nominee Kevin Warsh.
Warsh's plans for monetary policy are somewhat complicated -- he would like to both cut the Fed's target rate while shrinking the Fed's massive balance sheet. It's not exactly certain how that would impact overall borrowing costs. But certainly, if Trump has nominated Warsh, investors can assume he assured the president -- initially at least – that he'll push for a more aggressive rate-cutting schedule.
Right now, the Fed Funds Futures Market puts the chances of three or more cuts in 2026 at 43%. That's up from 25.6% just a month ago. So there's certainly growing optimism that the Fed is starting to lean toward additional rate cuts this year. That would give the entire stock market a shot in the arm. Stay tuned.
