In 2026, the Fed moved from an easing bias to a hold to a hike, catching up to the data with a lag at every stage. We look back at how (1) a bottoms-up read of inflation, (2) a careful reading of the labor market, and (3) close tracking of the full FOMC put us ahead of the hawkish turn.
In this note, we look back at how our detail-oriented approach to inflation nowcasting, the labor market, and Fedspeak led us to call the Fed's hawkish turn early in 2026. MacroSuite subscribers receive this analysis on a high-frequency basis. If you're interested in subscribing, please reach out to macrosuite@employamerica.org.
When the Fed raised rates last week, it didn’t come as a surprise to most Fed watchers. Most people anticipated a hike, and markets were pricing in a hike with near-certainty. However, that wasn’t always the case; in the spring most were still anticipating an indefinite hold or the next move to be a cut, and as late as Chair Warsh’s hawkish Jackson Hole speech, most Fed watchers anticipated the Fed would hold rates steady this year.
By contrast, we were among the few that were quick to catch on to the Fed pivot away from an easing bias to a neutral bias in the spring, and relatively early in seeing a Fed hike this year. Our early call was the result of the same blocking-and-tackling approach to macro data and Fed analysis that led us to correctly call the 50 basis point cut at the September 2024 FOMC. Three key aspects of our process led us to this call:
In this note, we look back at the role that these three strategies played in our Fed analysis in 2026, from our shift to an indefinite hold in February, to our move to a hike call in May, and our arrival at a September hike call in July. Consistently applying these three aspects of our process kept us ahead of most Fed watchers for most of the year.
Coming into 2026, the Fed, markets, and most Fed watchers, including us, saw cuts as the base case. In the December 2025 dot plot, twelve members penciled in cuts for 2026, with eight projecting at least two. Markets were pricing in two cuts by year-end. But following the January CPI release, we shifted our call to an indefinite hold for 2026 absent labor market deterioration or a sharp contraction in financial conditions, while the market was still pricing in multiple cuts in 2H2026.
As the data fog from the government shutdown started to clear in February, it became clear to us that the Fed was behind the curve on inflation. Tariff pass-through was outrunning the Fed's expectations, market-based "supercore" (a measure of services inflation that excludes lagging housing data and prices not observed in market transactions) was running hot, and inflationary pressures from the AI buildout were starting to emerge with the potential to broaden out.
A key part of our call came from our realization that the noisy labor market data in the early months of 2026 was showing stability, even though there were opportunities to cry wolf. For example, the February jobs day data delivered an ugly 92,000 net jobs lost in the initial release. However, our longstanding instinct of shading the initial payrolls releases in favor of the household survey numbers proved correct, and probably reflected the thinking of key FOMC members like Waller.
For us, the implication of these developments for the Fed was fairly simple: The Fed delivered insurance cuts late last year, fearful that the labor market was deteriorating and confident in a downward inflationary trajectory. By early 2026, it was apparent to us that the Fed was wrong on both fronts and that cuts would not be coming anytime soon.
As we moved into the spring, the Fed’s tardiness to the inflation picture was getting worse. The Strait of Hormuz closure in late February added yet another source of inflationary pressure, raising the upside risk to market-based supercore through the potential pass-through of higher jet fuel, diesel, and fertilizer prices into airfares and food away from home – two categories that had already been running hot before the closure.
Despite these developments, the median Committee member still projected a cut in 2026 at the March FOMC meeting. The median projection for core PCE inflation in 2026 was 2.7%, a path that required a substantial and sustained slowdown for the rest of the year.
The Committee was catching up to every inflationary impulse with a lag:
The Fed was unable to explain the myriad of supply-side and microeconomic drivers of inflation, and their current framework isn’t equipped to deal with them. Paired with big inflation forecasting misses, this left them data-point-dependent with a lag, and liable to fall behind and then having to play catch-up as the inflation picture worsened. Given the vast gap between where the Fedspeak was and where the data was pointing, we knew the Fed would have to pivot quickly away from an easing bias as they followed the data with a lag.
So far, the movement of the Committee towards a tightening bias has been fairly limited, with a minority of members putting much weight on the probability of a hike as the next move. But if you put together the whole picture—inflation at least 100bp over target and rates only 50bp above their neutral estimate, elevated supercore inflation, a labor market that looks pretty steady, stable financial conditions—we’re betting the Committee is probably internally more hawkish than they are currently projecting. Perhaps they are waiting for more data, or perhaps they are waiting for the Fed Chair nomination story to play out, but there is a real possibility of a hawkish pivot later this year.
Our April 2026 FOMC Preview (April 24th, 2026)
Complicating the picture was the transition of the Chair from Powell to Warsh. The speculation around whether Warsh would deliver rate cuts for the President, whether he was merely courting the President's desire for lower rates before letting his former hawkishness reemerge, and what his "task forces" might produce was mostly noise. Ahead of his confirmation hearing, we flagged that (1) Warsh faced an uphill battle earning the trust of his colleagues, given how far his recent positions had drifted from his long hawkish record, and, most importantly, (2) the one view he never flip-flopped on was his belief that the Fed should talk less. With the Chair staying quiet, the signal for the rate path would come from the rest of the Committee.
Chair Warsh will face elevated suspicions from the rest of the FOMC when presenting his case for cutting interest rates given his previously expressed hawkishness and his more recent professed alignment with the President's preferred interest rate policy. Chair Warsh is unlikely to carry clean majorities, and especially if Powell were to stay on as Governor until January 2028.
Fed Note: The Implications Of The Kevin Warsh Nomination. January 31st, 2026
We saw pushback against his ideas from the rest of the Committee on his arguments that AI-driven productivity growth would lead to lower interest rates and the use of asymmetric trimmed mean inflation measures. Fedspeak that specifically argued against Warsh’s views (even though they rarely mentioned him by name), combined with the three dissents against an easing bias at the April meeting (just before Warsh took office), sent a strong signal that the Committee was going to think for itself.
This meant that our long-standing practice of following Fedspeak from all Committee members (which we compile in our Fedspeak Monitor) only became more important during the transition from Powell to Warsh. For the rest of the year we paid close attention to what every member of the Committee was saying about their personal views about the rate path, paying special attention to key moderates on the Committee that might serve as swing votes on a rate hike.
In early May, we saw enough strength in the April jobs data that we anticipated that the moderates on the Committee would feel they had the permission they needed to switch their attention to the inflation side, likely with a lagged response to data developments. The labor market was showing remarkable resilience, unemployment was falling, and there were even potential signs of a labor market reacceleration. We anticipated that the bulk of the FOMC would soon be publicly moving away from an easing bias (at the time, pushback against further rate cuts was isolated to a few hawkish regional Fed presidents).
Soon after, the Fedspeak shifted quickly. Opposition to a rate cut as the base case was not limited to Hammack, Logan, and Schmid, the most hawkish members of the Committee. We saw more moderate members like Musalem, Collins, and Goolsbee switch to a neutral bias; the more dovish members Waller and Paulson soon followed.
The direction of travel was clear, and by mid-May, we moved our Fed call from an indefinite hold to a hike in 2027, and by the end of May moved our hike projection up to 4Q2026. Our call sat well outside consensus as most sell-side Fed watchers expected a hold or a cut next.
As we anticipated, the Fedspeak moved towards laying the groundwork for a hike. In early June, the hawks started talking more explicitly about a hike being the next move, prompting us to move our hike call up to October with two hikes.
Warsh's first meeting in June confirmed the shift: 9 of 18 participants saw hikes by year-end and only one saw a cut, down from 12 in March. Many commentators and analysts credited Warsh for the hawkish turn, but before he even gave his press conference, stocks had sold off, the dollar had strengthened, and front-end yields had moved sharply higher, all in response to the SEP that he declined to participate in.
By July, it became clear that Waller and Williams would be the key deciding votes, and they began to lay out explicit conditions for the inflation data that would be required for them to support a hike. We finally moved our Fed hike call to September in late July.
Throughout this phase, the labor market remained resilient. While the labor market never quite reaccelerated, there were enough green shoots that the FOMC would feel comfortable talking up the possibility of raising rates this year. Knowing how to read the labor market data was crucial to avoid getting head-faked by the sharp drop in employment in June or the negative payrolls print in July or falling non-age-adjusted labor force participation rates. This helped us maintain our view that the Fed was going to hike this year.
By the time Waller and Williams had laid out explicit guidelines for when they would consider a hike appropriate, we (and the market, and other Fed watchers) were simply following the reaction function that those key FOMC members laid out. There was some whiplash in our Fed views after the July inflation data came in soft, but that was appropriate given the data point dependence that the Fed had boxed itself into. The upside to airfares, food services, communication services, and tech equipment inflation we anticipated ahead of the August inflation data materialized, and the pickup in lodging away from home we had been expecting for several months finally arrived – all but locking in a September hike.
Over the course of 2026, the Fed moved from an easing bias to a hold to a hike, and at each stage the Committee caught up to the data with a lag. Our bottom-up inflation work showed that inflation was coming from multiple fronts; our detail-oriented reading of the labor market data kept us from getting head-faked by the noise; and our tracking of the full Committee showed where the rate path was heading amidst all the theorizing about what a new Chair would mean for the Fed.
At the end of the day, the blocking and tackling of macro always wins out – especially when the Chair chooses to stay silent and a cottage industry of analysts emerges claiming unique insight into his instincts, mannerisms, and plans for "regime change" at the Fed. Taking a careful look underneath the hood of each data release and understanding the FOMC’s framework and reaction function told us where the Committee was headed before the Committee said so itself. The path ahead will be determined by the same forces.