UOB has revised its Federal Reserve outlook after hotter US inflation data. It now expects the Fed to keep policy rates unchanged through 2026, then deliver two rate cuts in 2027, with cuts in late Q2 2027 and late Q4 2027.
Under this path, UOB projects the federal funds target rate at 3.75% by end-2026 and 3.25% by end-2027. It expects 3.25% to be the terminal Fed rate.
UOB notes softer domestic demand linked to rising energy costs, while hiring data in March and April were above expectations. It has raised its US CPI forecasts for 2026 again, saying risks remain biased upwards and inflation remains above the 2% target.
It also cites persistent upstream inflation pressures as a factor that could delay any easing cycle. Separately, it refers to whether Warsh can gain support or reach consensus among voters on the direction of Fed monetary policy.
The piece was produced using an AI tool and reviewed by an editor. It is attributed to the FXStreet Insights Team.
The expectation has shifted towards an extended period of the Fed holding rates steady for the rest of 2026. This comes after the April CPI data showed core inflation remaining stubborn at 3.6%, failing to cool as we had hoped. The market is now fully pricing out any rate cuts for this year, a major change from the more optimistic sentiment we saw in late 2025.
For those trading interest rate futures, this suggests the “higher for longer” narrative is firmly in place for the coming months. We are seeing a flattening of the yield curve as the market digests that relief from high rates is much further away than previously anticipated. This makes positioning for an eventual easing cycle a trade for 2027, not 2026.
This extended pause creates a tricky environment for volatility, which has been creeping up with the CBOE VIX Index now holding above 17. Selling short-dated options strangles on equity indices could be a viable strategy, aiming to profit from markets that may become range-bound as long as no major economic shocks occur. However, the strong hiring numbers from March and April suggest the economy can handle these rates for now, reducing immediate recession fears.
The new forecast for two rate cuts in 2027 seems distant, but positions can be built now using options on SOFR futures. We should consider establishing calendar spreads, selling shorter-dated contracts and buying contracts for mid-to-late 2027 to play the eventual policy pivot. This is a bet that the Fed will have to act by then as the cumulative effects of the long pause from 2025-2026 take their toll on the economy.
We also need to monitor the internal debate at the Fed, especially with more hawkish voices potentially gaining influence. Persistent inflation could complicate the policy outlook and delay any easing cycle even further than currently projected. This underlying uncertainty suggests keeping some exposure to volatility products as a hedge against a sudden policy surprise.
