Jeffrey Schmid, President of the Federal Reserve Bank of Kansas City, said it makes sense to keep monetary policy restrictive while inflation is near 3%. He said inflation at this level suggests demand is still strong and is growing faster than supply.
He warned that more interest rate cuts could let higher inflation last longer. He also said he does not see clear signs that current rates are slowing the economy.
Productivity And Inflation Tradeoffs
Schmid said stronger productivity could support faster growth without pushing inflation higher, but he said the economy is not there yet. He added that recent productivity gains may partly come from workers staying in their jobs longer, not just from technology.
He also said there are ways to reduce demand for bank reserves, which could allow the Federal Reserve to run a smaller balance sheet. He said price shocks are “transitory” depending on how the central bank responds, and he stressed that the Fed should stay focused on its 2% inflation target.
Inflation remains stubborn. For example, January 2026 Core CPI came in at 2.9%. This strengthens the case for keeping policy restrictive. We think this means further rate cuts could be pushed back, which would challenge current market expectations. It also suggests demand is still running ahead of the supply improvements seen as supply chains recovered through 2025.
Recent data also supports the view that interest rates are not strongly restraining the economy. The economy added more than 250,000 jobs in January 2026, showing solid momentum. With the labor market still this strong, it is harder for the central bank to justify easing policy.
Implications For Rates Markets
Derivative traders should consider that markets may be pricing in too many rate cuts for 2026. The CME FedWatch tool shows expectations for three or four cuts this year, which now looks too optimistic. We are considering trades that benefit from fewer cuts, such as selling SOFR futures for the second half of the year.
This gap between Fed messaging and market pricing may raise bond market volatility. In the past, this kind of divergence has led to choppy trading, as it did in late 2025 during a similar period of uncertainty. We think buying options tied to interest rate volatility, using instruments that track the MOVE index, could be a sensible way to position for this risk.
A “higher for longer” rate backdrop also affects the yield curve and stocks. We expect renewed pressure for the yield curve to flatten, which could make trades on the spread between 2-year and 10-year Treasury futures more attractive. For equities, higher rates can weigh on growth sectors, so protective put options on tech-heavy indices may be worth considering.
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