Hot US inflation cools Federal Reserve rate cut hopes

The Federal Reserve's preferred inflation measure is again moving away from the central bank's target, dimming the outlook for near-term interest rate cuts.

The core personal consumption expenditures (PCE) price index, which strip out volatile energy and food prices, increased 3.0% year over year in December 2025, marking the largest annual increase since April 2024, the US Bureau of Economic Analysis reported Feb. 20. This measure of inflation, which the Fed wants at 2%, has now been on the rise since October 2025 and saw annual growth average 2.8% that year — nearly unchanged from 2024 when it averaged 2.9%.

The core consumer price index, the market's preferred inflation measure, increased 2.5% from a year earlier in January, the lowest since March 2021. Still, this is likely not enough to justify a cut until at least the second half of the year, according to market strategists and economists.

"If core PCE is coming in sticky and not convincingly trending toward 2%, that reinforces the Fed's cautious stance," Daniela Hathorn, a senior market analyst with Capital.com, said in an interview. "Even if GDP is moderating, as long as growth remains positive and the labor market is relatively firm, the Fed does not feel pressured to ease. In that sense, the data don't eliminate cuts from the outlook, but they do justify pushing them further out."

Adjusted for inflation, the US gross domestic product grew 1.4% annually in the fourth quarter of 2025, partly due to the record federal government shutdown, the Bureau of Economic Analysis reported Feb. 20. GDP grew at an annual rate of 4.4% in the third quarter.

The report of slower GDP growth followed the Feb. 19 US Census Bureau release showing that the country's goods trade deficit hit a record high, as well as the Bureau of Labor Statistics' revision of 2025 job growth estimates down from 584,000 jobs to just 181,000.

A slim majority of the futures market expects the Fed to pause on rate cuts until June, when Fed Chair Jerome Powell's replacement is expected to have taken over the helm of the central bank. About 52% of the futures market expected at least one cut at the June meeting, according to CME FedWatch.

"The hotter-than-expected PCE report may temper some of the optimism sparked by last week's cooler [consumer price index] print, but neither report should materially alter expectations for rate cuts," said Bret Kenwell, a US investment and options analyst at eToro. "The debate has been 'when, not if' on cuts, with policy held steady in the interim."

About 70% of the market expects at least two cuts by the end of the year, according to CME FedWatch.

James Knightley, chief international economist with ING, said he expects a cut in June and one more in September "once there is a little more comfort on the inflation story."

Several members of the rate-setting Federal Open Market Committee showed reluctance to cut rates with inflation still above their 2% target, according to the minutes of the committee's January meeting, released Feb. 18.

Fed Governor Stephen Miran, who has pushed for cuts, scaled back his expectations for just how low the benchmark should go, according to an interview published Feb. 19 in The Peg, a Substack page.

"Those comments were noteworthy in that he sees less accommodation," Michael O'Rourke, chief market strategist at JonesTrading, said in an interview. "As the most dovish Fed official by a wide margin that is an important statement."

The Fed's rate plans are particularly murky as large increase in capital expenditure spending and a memory chip shortage could cause a further increase in inflation this year, which could spark more talks of interest rate hikes between Fed officials, O'Rourke said.