While mainstream Wall Street institutions are broadly betting on the Federal Reserve restarting its rate hike cycle this year, divergent voices are emerging from deeper within the market. Some analysts argue that although recent U.S. inflation data appears to be rebounding, adopting the measurement standards preferred by the Fed itself reveals that inflation has actually shown a clear cooling trend. This implies that the market may have misjudged the necessity for further monetary policy tightening.

Multiple institutions, including major banks, previously estimated that impacted by trade tariffs, geopolitical tensions, and oil price fluctuations, the Fed might raise rates by 25 basis points in September, October, and December respectively, totaling 75 basis points for the year. However, latest market analysis suggests the likelihood of this aggressive expectation materializing is diminishing. Recently released inflation data has actually released positive signals, indicating that the phase of rapid inflation experienced by the U.S. might have ended, rather than restarting.

The bond market appears to have priced in this shift in expectations already. Although the Core Personal Consumption Expenditures (PCE) price index rose to recent highs, superficially strengthening the rationale for rate hikes, the U.S. two-year Treasury yield, which is most sensitive to policy, fell following the data release. This indicates investors did not interpret the inflation report as a signal of more imminent rate hikes, but rather believe the worst inflation expectations have been fully priced in.

The key to the market misjudgment lies in overlooking the inflation indicators truly focused on by some Fed officials. Most investors focus on the Core PCE price index excluding food and energy prices, but this indicator remains susceptible to distortion from outlier price fluctuations. In contrast, the Fed internally tends to refer to the Trimmed Mean PCE price index compiled by the Dallas Fed. This indicator not only excludes food and energy but further eliminates goods and services with the largest monthly price volatility, capable of more accurately reflecting underlying inflation trends. Currently, there is a significant divergence between the two indicators; Trimmed Mean data shows the inflation rate is far lower than the core indicator, implying that if policymakers prioritize the latter, the U.S. inflation situation is far less severe than the market imagines.

Multiple Fed officials have recently signaled patience. The New York Fed President expects inflation to continue declining in the coming quarters, believing existing monetary policy is sufficient to achieve targets. The St. Louis Fed President previously also stated the Fed is prepared to remain patient at current restrictive interest rate levels. Notably, when these remarks were made international oil prices were still at elevated levels, but have since fallen significantly; declining energy prices further alleviate future inflation pressure. Meanwhile, the dollar continues to strengthen, the Fed balance sheet continues to shrink, and U.S. interest rates remain significantly higher than most developed economies; these factors all suggest the Fed does not have an urgent need to raise rates further.

Market analysis suggests this does not mean the Fed will cut rates soon, but the consecutive rate hikes currently priced in by the market may never happen. If the market ultimately corrects this expectation, U.S. stocks could welcome a new upward catalyst. Particularly in real estate, utilities, technology, and other interest rate-sensitive sectors; when investors no longer worry about rate hike risks, stocks currently under pressure due to high rate expectations could instead become the leading force for the next market rally.