Inflation Outlook Remains Contained
The team sees inflation staying contained, with data distortions in Q4 not changing the broad path. It expects slower housing inflation and lower unit labour cost growth to limit overall inflation, while tariff pass-through lifts goods and food prices in 2026. Headline inflation is forecast at 2.4% in 2026, down from 2.5%, and 2.4% in 2027, unchanged. Core inflation is forecast at 2.5% in 2026, down from 2.8%, and 2.6% in 2027, unchanged. It expects two 25 bps Federal Reserve rate cuts in June and September 2026, delayed from March and June. After that, it forecasts a terminal rate of 3.00% to 3.25% through the rest of 2026 and all of 2027. With our expectation for Federal Reserve rate cuts now pushed to June and September, the path forward appears less aggressive. The latest February CPI data, showing core inflation holding firm at 2.5%, supports this patient approach from the central bank. This means the market must adjust away from the more dovish outlook it held at the end of last year.Implications For Rates Markets
This outlook suggests that short-term interest rate futures may be overstating the case for deeper cuts later in the year. The February jobs report showed wage growth cooling to 3.8% annually, reinforcing the view of a slowing, but not collapsing, economy that doesn’t require drastic Fed action. Therefore, positions that bet on a terminal rate holding around 3.00-3.25% appear well-founded for the coming weeks. Looking further out, the forecast for a steady policy rate through 2027 suggests a period of lower volatility is on the horizon. The MOVE index, which tracks bond market volatility, has already dipped below 90, a stark contrast to the levels above 120 we saw during the uncertainty of 2025. This creates potential opportunities to sell volatility on longer-dated options, anticipating a calmer interest rate environment post-September. For equity index derivatives, this environment supports range-bound strategies, such as selling iron condors on the SPX. The economy is not strong enough to break significantly higher, but the prospect of eventual cuts should provide a floor for the market. This scenario of steady growth and contained inflation is likely to keep major indices within a predictable channel. We must remain aware of the balanced risks to this outlook, particularly the potential for a sudden slowdown in consumer spending. Given this, holding some cheap, out-of-the-money puts on consumer discretionary ETFs could be a prudent hedge against a negative surprise in consumption data. Conversely, a global manufacturing boom could delay cuts, making calls on industrial sector ETFs an interesting consideration. Create your live VT Markets account and start trading now.
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