Kashkari pivots from rate cut to one hike in 2026 as inflation persists

The Fed's most dovish official has flipped his 2026 rate call, a shift that underscores how persistent inflation and Middle East supply shocks are reshaping the policy outlook.

Minneapolis Federal Reserve President Neel Kashkari said Friday he now expects one interest rate increase by year-end, reversing his March projection for a cut as the central bank's preferred inflation gauge hit its highest level in more than three years. "In March, I had penciled in one rate cut by the end of the year. In June, I've changed that to one rate hike by the end of the year," Kashkari said at the Aspen Ideas Festival in Colorado. The policymaker is a voting member of the Federal Open Market Committee this year.

The Commerce Department reported Thursday that the core personal consumption expenditures price index, which strips out food and energy, rose 3.4 percent from a year ago in May — the highest since April 2023. The headline PCE index accelerated to 4.1 percent, also the hottest reading since April 2023. Energy prices tied to the Middle East conflict drove much of the increase, with related goods and services up 4 percent for the month. Kashkari said he does not "trust Iran to honor whatever agreement has been made," citing overnight evidence of reneging on a ceasefire.

The shift carries weight because Kashkari was among the FOMC's more dovish members. Nine of 18 officials who submitted quarterly projections at the June 17-18 meeting penciled in at least one rate increase by year-end, according to the Fed's dot plot. The committee held the federal funds rate at 3.50 percent to 3.75 percent, where it has sat since the last adjustment. New Fed Chair Kevin Warsh stressed the importance of price stability in the post-meeting statement, which removed language hinting at future cuts.

Why the inflation outlook is broadening

Kashkari pointed to three forces keeping price pressures elevated: Middle East energy disruptions, tariffs pushing up imported goods, and a surge in AI-related capital spending. "Hundreds of billions of dollars a year into data centers and all of the associated infrastructure," he said. "Anything that touches those sectors, the prices are skyrocketing." The AI investment boom — spanning chips, data centers, and construction — adds demand-side pressure that complicates the return to 2 percent inflation, a dynamic also flagged by other Fed officials.

The broadening of inflation beyond energy is the key concern. Financial services and insurance costs jumped 1.2 percent in May, while housing rose 0.3 percent. Consumer spending remained resilient, climbing 0.7 percent for the month, matching personal income growth of 0.7 percent — both above forecasts. The personal saving rate edged up to 3 percent.

What markets are pricing now

Treasury yields have moved lower in recent weeks as oil prices eased, with the 10-year note ending last week at 4.37 percent, its lowest in six weeks. Brent crude fell below $72 a barrel even as President Donald Trump accused Iran of violating the ceasefire by targeting cargo ships in the Strait of Hormuz. Markets have pared expectations for Fed tightening, though traders still see a September hike as possible.

The last time the Fed faced a comparable inflation overshoot driven by energy supply shocks was in 2022, when the central bank delivered 75-basis-point hikes over four consecutive meetings. The current situation differs in that the economy is stronger — first-quarter GDP was revised up to 2.1 percent annualized, and initial jobless claims fell to 215,000 — giving the Fed more room to hold steady before acting.

The FOMC next meets July 28-29. Kashkari said his penciled-in hike is conditional on incoming data. "It's a pencil, and so we're going to have to see how the data comes in," he said. If inflation does not moderate, the shift from projecting a cut to projecting a hike represents a material repricing of the rate path that will flow through to mortgage, auto, and corporate borrowing costs before any actual move.

This article is for informational purposes only and does not constitute investment advice.