The high prices of refined oil products and the accelerating rise in housing costs are making it more difficult for inflation to return to the 2% target. Economists believe the Federal Reserve may need to take more aggressive policy actions, but the larger the interest rate hike, the more vigilant we should be about the risk of policy mistakes.
Written by: Wu Yu, Golden Ten Data
While the sustainability of AI trading remains a market focus, investors may also need to be alert to another risk: excessive tightening policy by the Federal Reserve to curb inflation, which could become a major threat to US stocks in 2027.
Neil Dutta, Head of Economic Research at Renaissance Macro Research, said in an interview with MarketWatch on Tuesday that the current job market is strengthening and the unemployment rate is falling, but inflation is moving further away from the Fed's 2% target. This combination significantly increases the risk of policy overtightening.
"I do think overtightening is a major risk," Dutta said.
Federal Reserve Governor Christopher Waller, speaking in London on Tuesday, signaled the possibility of further rate hikes. He stated that if the October CPI data released that day was similar to the previous two months, with core CPI monthly growth reaching 0.3% or higher, the Fed might need to adopt a tougher policy stance and consider a 50 basis point rate hike at the December meeting.
The subsequently released data showed the core CPI monthly rate for October was 0.3%. Following the data release, US Treasury yields rose quickly, with the 10-year yield returning to 5%.
Inflation pressures are building again, and rate hikes could exceed market expectations
Dutta believes it remains to be seen whether Waller's stance will be supported by other Fed Governors. However, the latest economic data indicates that current interest rates may still be insufficient to effectively curb price increases.
Although crude oil prices have fallen since the US midterm elections, prices of refined oil products such as diesel remain elevated. Meanwhile, housing costs are showing signs of accelerating, further complicating efforts to bring down inflation.
Dutta pointed out that the inflation data released on Tuesday for October suggest rental housing costs may be accelerating again. If housing price growth does not slow, it will be difficult for the Fed to pull overall inflation back to the 2% target.
In a report sent to clients on Tuesday, he wrote: "In short, the Fed remains too optimistic about inflation, and the market is too complacent about the degree of tightening required to achieve the inflation target."
US Treasury yields surge as the market reprices the path of rate hikes
The bond market has already begun to reflect expectations of a tougher monetary policy. Dow Jones Market Data shows that on Tuesday, the yield on the 2-year US Treasury bond, the most sensitive to Fed rate expectations, rose 19 basis points to 4.75%, marking the largest single-day increase since April 2025 when Trump announced tariff policies that disrupted global markets.
The widening spread between the 2-year US Treasury yield and the Fed policy rate also reflects that bond investors are signaling to the Fed: the market anticipates the need for larger interest rate hikes in the future.
Currently, investors expect the Fed to raise rates by a total of 50 basis points in the coming months, consistent with the latest forecasts released by senior Fed officials in September. This means that the 75 basis point "insurance" rate cuts implemented by the Fed in 2025 will be completely reversed.
But Dutta believes that merely recouping previous rate cuts may no longer be enough. In his report, he wrote: "For now, undoing last year's insurance rate cuts is just the bare minimum."
