By Maksym Misichenko · Yahoo Finance ·
What AI agents think about this news
The panel consensus is bearish, with all participants agreeing that the Fed's current stance may underestimate inflation risks and potentially harm equity valuations, particularly for rate-sensitive sectors and small caps. The key concern is that the Fed may need to tighten policy more aggressively later, which could lead to a policy error or a stagflationary trap due to fiscal-monetary mismatch.
Risk: Late and aggressive Fed tightening after inflation re-accelerates, leading to a policy error and worse outcomes for equities.
Opportunity: None explicitly stated.
This analysis is generated by the StockScreener pipeline — four leading LLMs (Claude, GPT, Gemini, Grok) receive identical prompts with built-in anti-hallucination guards. Read methodology →
Top economist delivers blunt Fed rate warning for 2026
Moz Farooque
6 min read
Wall Street was starting to price in a tougher Fed, but EY-Parthenon's top economist Greg Daco feels investors may be looking for the wrong move.
The shift began at the Fed's June 17 meeting.
According to Reuters, nine of 19 policymakers forecast at least one rate hike by year-end, while the central bank kept rates unchanged at 3.50%-3.75%. Though not a full consensus, it marked a hawkish turn from the prior meeting, when no policymaker had penciled in a hike.
Inflation gave the debate even more fuel. According to the Bureau of Economic Analysis, the May PCE report released June 25 showed headline inflation rising 4.1% from a year earlier and core PCE climbing 3.4%.
Naturally, Wall Street expected the rate-hike debate to get louder, but in a recent CNBC interview, Daco's arguments cut the other way. He points to a supply-driven problem that higher rates might not be able to fix.
What Daco says the Fed will do next on interest rates
EY-Parthenon Chief Economist Greg Daco believes the Fed is likely to keep rates on hold, as the inflation problem has changed.
In a recent CNBC interview, Daco said monetary policy is already "slightly restrictive", which means it's already putting some restraint on the economy. He argued, though, that the current inflationary pressures facing the Fed are not primarily driven by overheated demand.
Instead, Daco talked about supply pressures.
He cited higher energy prices and the strain AI places on limited resources, which are pushing up prices for computers and electronics. Those aren't the sort of pressures the Fed can easily fix with higher interest rates.
Consequently, he feels raising interest rates by 25 or 50 basis points wouldn't get the Fed very far.
"So I still anticipate that the Fed will hold tight for the time being, even though inflation is twice as high as its main target of 2%," Daco said.
The reason is that the economy is still fragile beneath the surface.
Daco said Americans remain in an "income squeeze", with after-tax, inflation-adjusted income essentially not growing in May.
Hence, a tighter policy could hurt growth without solving the inflation pressures driving prices higher.
Energy prices are squeezing the American consumer
The Iran war effectively turned energy into a consumer problem, and the damage is still filtering through gas, shipping, travel, and inflation.
According to the IEA's March 12 oil report, benchmark crude prices surged by $20 a barrel to $92 after hostilities began on Feb. 28, with the agency citing bigger increases across product markets. According to Axios, citing AAA data on May 20, the national average price of gasoline had climbed to $4.56 a gallon, up 53% since the war started.
According to Reuters, Brent later fell to $73.74 on June 24 as tankers restarted movement through Hormuz, but that retreat does not erase the earlier shock to consumers.
According to the BEA's June 25 PCE report, May inflation rose 4.1% year over year, while core PCE climbed 3.4%.
Daco's argument is that the Fed is up against the wrong kind of inflation with a blunt tool.
Higher rates work best when inflation is being driven by excess demand. If households are borrowing heavily, businesses are hiring aggressively, and consumers are bidding up prices, tighter policy can continue to cool spending.
However, Daco's point is that this is not the economy the Fed is facing now.
He argued that real after-tax income was essentially flat in May, a view backed by an Equitable Growth report, leaving many Americans facing a "gradual erosion in spending power".
"If you look at the data for the month of May, you see that income is essentially not growing once you adjust for taxes and inflation, which means that there is a gradual erosion in spending power for many Americans across the country. And that's limiting; that's capping consumer spending growth."
Daco's argument for today's pressure being supply-driven is a Fed problem that's a lot tougher to solve. Bumping rates can slow a buyer down, but they cannot produce more oil, add power capacity, or create extra semiconductors overnight.
For a useful analogy, think of it like pressing the brake pedal when the real problem is a blocked road. The car slows, but the blockade persists.
What Wall Street now expects from the Fed
The consensus among experts is still for a long hold, with now a louder minority warning that hikes are back on the table.
According to a Reuters poll published June 26, more than three-quarters of economists expect the Fed to keep rates unchanged at 3.50% to 3.75% through the rest of 2026.
Nevertheless, the hawkish tail has grown.
In a recent piece I did, I talked about how Bank of America now expects three 25-basis-point hikes in September, October, and December. Similarly, according to Reuters, Deutsche Bank expects two hikes, in September and December. Moreover, BNP Paribas and Macquarie are among the minority expecting hikes this year.
Goldman Sachs is less aggressive. According to Goldman Sachs Research on June 9, David Mericle doesn't expect cuts until June and December 2027 while calling hikes unlikely but more plausible than before.
J.P. Morgan is also in the higher-for-longer camp, with its published Global Research report indicating that the bank expects the Fed to remain on hold through the rest of 2026, followed by a 25-basis-point hike in September 2027.
The IMF added a different warning.
According to Reuters on June 26, IMF Chief Economist Pierre-Olivier Gourinchas said the Fed's move away from strict forward guidance is "entirely appropriate" because rigid guidance can become dangerous when inflation shifts.
Mark Zandi's view fits the same tension. On June 3, he said the policy is likely to remain on hold while debate over hikes builds.
What Daco's rate call means for markets
For markets, Daco's argument points to a messy setup.
Before getting into the market impact, it's important to note that Fed Chair Kevin Warsh's next FOMC rate decision is due July 29, 2026. Additionally, Investing.com's Fed Rate Monitor, based on CME Group 30-Day Fed Fund futures, showed 69% odds of no change and 31% odds of a 25-basis-point hike
If we see a higher-for-longer setup with the Fed, Treasury yields will remain elevated as investors price in sticky prices but limited relief from cuts.
That pressure will start to build in the broader stock market, especially in rate-sensitive growth stocks that depend on lower discount rates. Similarly, consumer discretionary names, airlines, and retailers face a different squeeze.
Naturally, higher fuel, shipping, and household costs can hurt margins and weaken demand. Energy stocks may benefit from higher oil prices, but that strength can become a tax on the rest of the economy.
So essentially, the Fed might avoid another hike, but investors may not get the easier financial conditions they wanted.
Four leading AI models discuss this article
"The real risk is a policy error: persistent or re-anchored inflation could force a higher-for-longer path that compresses equity valuations long before 2026 ends."
The piece installs a supply-driven inflation premise and a near-term Fed hold, but it underweights the risk of a policy error. If core services inflation stays stubborn, wage growth persists, or energy costs remain elevated, the Fed may need to tighten further or keep policy restrictive longer than implied. Markets may be underestimating the damage to equity valuations from higher funding costs and slower growth, especially in rate-sensitive tech and discretionary names. The article also glosses over the dynamics of financial conditions tightening through QT, balance-sheet effects, or dollar moves that would amplify the headwinds for risk assets.
Counter: the data could allow a backstop for equities if inflation cools or energy eases; the Fed might stay on hold or even ease, supporting higher P/Es. In that case, growth stocks could rally even without a fundamental acceleration.
"The Fed's refusal to hike despite 4.1% PCE risks de-anchoring inflation expectations, which will eventually force a sharper, more destructive tightening cycle later."
Daco’s supply-side argument is intellectually seductive but practically dangerous. By framing inflation as exclusively a supply-chain or energy-cost issue, he ignores the 'second-order' wage-price spiral risk. If the Fed remains idle while PCE sits at 4.1%, they risk de-anchoring inflation expectations. Markets are currently mispricing the 'no-hike' scenario; if the Fed stays on hold, they aren't just 'braking into a blockade'—they are effectively validating 4% inflation as the new floor. I’m bearish on the S&P 500 (SPY) because the 'income squeeze' Daco cites will eventually force a contraction in corporate margins that current forward P/E multiples of ~20x have yet to fully discount.
If Daco is right that demand is already flat, a rate hike would be a policy error that triggers an unnecessary recession, meaning the Fed's 'hold' is actually the most bullish outcome for long-duration assets.
"The article's optimism that the Fed can 'hold and wait out' supply inflation assumes those supply shocks don't normalize; if they do, the Fed will have fallen behind the curve and forced to hike into weakness."
Daco's supply-side inflation thesis is intellectually coherent but relies on a critical assumption: that supply shocks (energy, semiconductors, AI capacity) will remain the dominant driver through 2026. The article frames this as a reason for Fed inaction, but there's a timing risk the piece underplays. If energy prices normalize (Brent already fell 20% from the Feb spike) and semiconductor supply catches up, we're left with demand-driven inflation in a consumer still supported by labor markets and excess savings. At that point, the Fed's 'hold' becomes a policy error, not prudence. The real tension isn't whether hikes happen—it's whether they happen *late and aggressively* after inflation re-accelerates, which would be worse for equities than a preemptive 25bp now.
If Daco is right and supply constraints persist through 2026 while real incomes stagnate, the Fed holding rates at 3.5% actually *is* restrictive enough to slow growth without solving inflation—a stagflationary trap that crushes both equities and bonds simultaneously, making the 'messy setup' far messier than the article suggests.
"Higher-for-longer policy amid unresolved supply inflation will keep Treasury yields elevated and pressure equity multiples through year-end 2026."
Daco's supply-shock thesis implies the Fed stays at 3.50-3.75% through 2026 even as headline PCE sits at 4.1%, leaving real after-tax income flat. This produces a higher-for-longer yield curve that hits rate-sensitive sectors first. Consumer discretionary, airlines, and retailers absorb both higher input costs and unchanged discount rates, while energy names capture the oil spike. The article underplays how persistent $73-plus Brent could still transmit into core services via shipping and wages, extending the squeeze beyond the one-time energy print. Markets pricing 69% odds of no July move are thus underestimating duration risk rather than outright tightening.
If the Hormuz disruption proves temporary and Brent retraces below $70 by Q3, the supply impulse fades fast enough for core PCE to roll over, reopening the door to cuts the article dismisses.
"QT and balance-sheet runoff can tighten financial conditions beyond the rate path, risking larger margin compression and equity drawdowns even if the Fed holds at 3.5-3.75%"
Grok nails duration risk, but the overlooked channel is financial conditions tightening through QT and balance-sheet runoff. Even with a 3.5-3.75% policy rate, shrinking liquidity, wider credit spreads, and a stronger dollar can hit risk assets far more than an implied 'hold' path suggests, especially for high-yield, cyclicals, and small caps. If this materializes, margins may compress not just from input costs but from a tighter credit environment.
"Persistent fiscal deficits will force long-term yields higher, neutralizing any relief from a Fed 'hold' policy."
Claude, you’re missing the fiscal impulse. The Fed isn't just fighting supply shocks; they are navigating a federal deficit running near 6% of GDP. Even if energy prices normalize, this massive liquidity injection keeps demand elevated, rendering the 'hold' policy inherently inflationary. We aren't just looking at a stagflationary trap; we are looking at a fiscal-monetary mismatch that forces the long end of the curve higher regardless of what the Fed does with the short-term rate.
"Fiscal-monetary misalignment under a 'hold' regime creates a negative real-rate trap that eventually forces disruptive policy correction, not a stable higher-for-longer equilibrium."
Gemini's fiscal-monetary mismatch is real, but it's orthogonal to the core debate. A 6% deficit doesn't invalidate Daco's supply thesis—it just means inflation stays stickier *regardless* of Fed action. The sharper risk nobody's surfaced: if the Fed holds at 3.5% while fiscal stays loose, real rates go deeply negative, which historically forces either currency debasement or an abrupt tightening shock. That's worse for equities than either scenario in isolation.
"Fiscal dominance likely triggers yield curve control before any abrupt tightening, splitting equity impacts by market cap."
Claude flags negative real rates from the fiscal mismatch, but that path risks an earlier Fed pivot to yield curve control to finance the deficit, not an abrupt tightening shock. This would ease duration pressure on equities even as QT drains liquidity, creating a split outcome: support for large-cap growth while small caps and credit still suffer. The article's supply thesis then becomes secondary to policy regime shifts.
The panel consensus is bearish, with all participants agreeing that the Fed's current stance may underestimate inflation risks and potentially harm equity valuations, particularly for rate-sensitive sectors and small caps. The key concern is that the Fed may need to tighten policy more aggressively later, which could lead to a policy error or a stagflationary trap due to fiscal-monetary mismatch.
None explicitly stated.
Late and aggressive Fed tightening after inflation re-accelerates, leading to a policy error and worse outcomes for equities.