Core PCE Stuck at 3.1% as Markets Abandon Hope for Fed Rate Cuts
January inflation data forces traders to reprice from six cuts in December to maybe one by year-end, triggering Treasury selloff and equity volatility.
Core PCE rose 3.1% year-over-year in January, in line with expectations but up from 3.0% in December, cementing the Federal Reserve’s extended holding pattern. The stickiness in services inflation, even as headline PCE edged down to 2.8%, has vaporized the soft-landing narrative that dominated markets just three months ago.
Rate-Cut Expectations Collapse
Traders pushed back expectations for the next Fed rate cut to mid-2027, a dramatic reversal from December when markets priced in multiple cuts through 2026. Traders now see only one cut coming in December, with no additional moves until well into 2027 or early 2028.
Goldman Sachs Research forecasts two more cuts from the Fed next year, leaving Interest Rates at 3-3.25%, while Goldman officially adjusted its rate forecast, pushing back the next cut to September from June. J.P. Morgan strategists still expect one rate cut in 2026, though markets see low odds of the Fed choosing to cut at its March meeting.
The repricing reflects mounting evidence that inflation isn’t following the script. Core PCE—which strips out volatile food and energy costs—remained stubbornly fixed at 3.1% YoY, signaling that the “last mile” of the inflation fight is proving to be a grueling marathon. Services prices were up 3.5% from a year ago in January, up slightly from the 3.4% services inflation rate that persisted from September through December.
Rising insurance premiums, increased healthcare costs, and steady wage growth in the service industry have created a “sticky floor” for core prices. The divergence between falling goods prices and persistent services inflation suggests the economy has entered a bifurcated phase where energy relief masks structural pressures elsewhere.
Treasury Curve Steepens, Equities Crack
The benchmark 10-year Treasury yield climbed to 4.27%—its highest level in months, while the 2-year UST sat at 3.73%. The yield curve has undergone a “bear steepening,” where long-term rates rise faster than short-term rates, reflecting a market that is pricing in stronger growth but also higher long-term inflation risks.
The move in rates has reintroduced what traders are calling “valuation gravity” to equity markets. High-valuation tech giants like Nvidia and Microsoft, whose valuations are heavily dependent on discounting future cash flows, have faced significant headwinds as the 10-year yield climbs, mathematically lowering their present value.
| Sector | Impact | Reason |
|---|---|---|
| Mega-cap Tech | Negative | Higher discount rates compress long-duration valuations |
| Regional Banks | Positive | Steeper curve widens net interest margins |
| Real Estate | Negative | Rising financing costs pressure commercial property |
| Value Stocks | Positive | Outperform growth when risk-free rate climbs |
The financial sector has emerged as a distinct winner, with large-cap banks such as JPMorgan Chase and Bank of America standing to benefit from a steepening yield curve. When long-term rates rise while the Fed keeps short-term rates steady, banks can borrow cheaply and lend at higher margins.
Fiscal Dominance and Policy Uncertainty
The inflation stickiness arrives as the Federal Reserve enters a leadership transition. Jerome Powell’s term expires on May 15, 2026, creating what market participants describe as a “policy vacuum” where Treasury Yields have become the primary barometer of economic health.
The timeline of this shift began in late 2025 following the passage of the “One Big Beautiful Bill Act” (OBBBA), a massive fiscal package that made several tax cuts permanent while injecting new infrastructure spending into the economy. This fiscal expansion pushed the national debt over $38.6 trillion, prompting bond “vigilantes” to demand a higher term premium for holding long-dated debt.
“The upshot is that the Fed should not be in a rush to ease rates further.”
— Stephen Juneau, Economist, Bank of America
Juneau noted that while some important components—housing, in particular—are showing signs of stabilizing or receding, inflation otherwise “has been rangebound and remains above levels consistent with 2% core PCE”.
The repricing accelerated after geopolitical tensions in the Middle East sent oil prices surging. Treasuries slumped as the prospect of a prolonged Iran war drove a surge in oil prices and revived fears of an inflation shock, with the selloff ripping through the $31 trillion US bond market. Analysts now project headline inflation could jump toward 4.5% by the second quarter if energy disruptions persist.
What to Watch
The March 17-18 FOMC meeting will be critical. While the rate-setting Federal Open Market Committee issues its next rate decision March 18, no rate change is expected. The focus will be on the updated dot plot and Chair Powell’s guidance on the path forward.
- February PCE data (due early April): Another 0.4% monthly core reading would cement the higher-for-longer narrative
- 10-year Treasury stability: A break above 4.50% would trigger broader equity rotation out of growth stocks
- Fed Chair nomination: Kevin Warsh widely seen as more hawkish successor to Powell
- Oil prices: Brent crude above $100/barrel would add 1-2pp to headline inflation by mid-year
The soft-landing consensus that dominated 2025 has given way to a stagflationary risk scenario where growth slows but inflation remains sticky. If the labor market weakens sooner and more substantially than expected, concern about the impact of higher oil prices on inflation and inflation expectations might not be an obstacle to earlier rate cuts, but that remains a secondary scenario.
For now, markets are repricing for a world where 4% is the new floor for long-term yields, not the ceiling. The discount rate matters again—and equity valuations built on the assumption of falling rates are being stress-tested in real time.