The Fed Is Done Cutting. The Question Now Is Whether It Hikes.

What Bank of America's three-hike forecast means for markets, borrowing costs, and the economy.

By Federalreserve - ea_06, Public Domain, https://commons.wikimedia.org/w/index.php?curid=50927842

Kevin Warsh's first meeting as Federal Reserve chairman ended on June 17th the way markets expected: no change to interest rates, held steady at 3.5% to 3.75%. But the projections underneath told a different story. Nine of eighteen policymakers now expect at least one rate hike before the end of 2026. A number that would have been unthinkable six months ago, when the consensus was still debating how many cuts the Fed would deliver this year. 

The rate-cut era is over. The debate now is whether the next move is up.

How We Got Here 

The Fed cut rates three times in late 2025, trimming 75 basis points as job growth softened and inflation appeared to be cooling toward its 2% target. Then two things derailed that progress. 

First came the tariffs. Then came the Iran war. 

When the U.S. and Israel struck Iran in late February 2026, traffic through the Strait of Hormuz––the waterway that carries 20% of the world's oil––was disrupted almost immediately. Oil prices jumped, gas prices climbed above $4 a gallon, and higher energy costs started pushing up prices across the broader economy. The Minneapolis Fed noted that this shock was different from a typical oil spike; not only because of its size, but because inflation was already running above 2% before the war started, reducing the Fed's usual tolerance for looking through energy-driven price increases. 

By April, the Consumer Price Index (CPI) had reached 3.3% year-over-year, the highest since May 2024, driven by the energy surge. Economists at EY-Parthenon warned that the Personal Consumption Expenditures index (PCE), the Fed's preferred inflation gauge, could hit 4% by year-end, double the Fed's target. 

That is the backdrop Warsh walked into. And at his first press conference, he emphasized the importance of restoring price stability roughly a dozen times, and was notably more cautious than expected about the prospect of AI-driven disinflation helping the Fed's cause. Markets read it clearly. The S&P 500 fell over 1% in the final hour of trading. Two-year Treasury yields jumped 14 basis points to their highest level in over a year. 

Bank of America's Call 

The week before the June meeting, Bank of America (BofA) expected no changes to interest rates in 2026. The week after, it reversed course entirely, projecting three consecutive quarter-point hikes in September, October, and December: lifting the benchmark rate from 3.5-3.75% to 4.25-4.50%. 

The reasoning is straightforward. BofA economist Aditya Bhave wrote that the Fed's inflation problem has gotten "unambiguously worse." Core PCE is tracking toward 3.5%, nearly 70 basis points above where it was a year ago. Housing-driven disinflation, which had been doing much of the work in cooling prices, has mostly run its course. Other core services remain sticky. Meanwhile, the labor market has not cracked. May payrolls came in at 172,000, unemployment held at 4.3%, and wage growth was still running at 3.4%––not the conditions that would give the Fed cover to ease. 

Bank of America is not alone. Deutsche Bank now expects two hikes in September and December. BNP Paribas and Macquarie are in the same boat. Goldman Sachs stopped short of calling for hikes but pushed any expected cuts into 2027. JPMorgan expects the Fed to hold through 2026, with the next move a hike in Q3 2027.

The Wall Street consensus has shifted from when and how much the Fed cuts, to whether it hikes and by how much.

Source: Trading Economics

The Counter-Argument 

Markets are not buying three hikes. Traders are currently pricing in one quarter-point increase by year-end, well short of BofA's 75 basis point projection. 

The case against the aggressive forecast is real. The Iran conflict has eased, oil prices have come down from their peak, and no market indicator is signaling three hikes in such a compressed window. The Fed itself, under Warsh, has shown no urgency to move at consecutive meetings. And hiking aggressively into a supply shock––where inflation is driven by energy and geopolitics rather than overheated demand––carries the risk of slowing growth without actually fixing the underlying price problem. 

Morgan Stanley's macro team noted that the Fed faces a genuine tradeoff in a supply shock environment: tightening to fight inflation can also slow growth and hiring, while easing to support the economy can pour fuel on inflation. There is no clean move available. 

What It Means for Markets and Households 

The stakes here go beyond the Fed's internal debate. Rate hikes ripple through the entire economy. 

Two-year Treasury yields, which are highly sensitive to Fed expectations, have already climbed to 4.24%, while the 10-year sits at 4.48% and the 30-year at 4.92%. Those moves raise borrowing costs for businesses financing expansion, homeowners taking out mortgages, and consumers carrying credit card balances. For a typical household with a $300,000 mortgage, $15,000 in credit card debt, and a $30,000 auto loan, even one additional hike translates to meaningfully higher monthly costs. Three would compound that pressure significantly. 

For the stock market, the math is equally uncomfortable. Equity valuations, particularly in the AI and technology sectors, which have driven most of this year's gains, depend heavily on the assumption that borrowing remains relatively cheap and that corporate earnings keep growing. Higher rates pressure both. The S&P 500 is still holding near record territory at around 7,470, but the bull case requires a specific combination: inflation cooling toward 2%, job growth slowing without breaking, Treasury yields easing, and corporate earnings staying strong. BofA's three-hike scenario makes every one of those conditions harder to achieve simultaneously. 

The Real Question 

The Fed has spent five years navigating shocks––pandemic, tariffs, and now a war––each of which complicated its ability to hit its 2% inflation target. Each time, the argument was that the cause was temporary and the Fed should look through it. The concern now, as one Fed economist put it, is that:

"A world where we had been at 2% inflation would feel a little different than this world where we have been at 3% inflation for a couple of years." 

The patience is wearing thin. 

Whether BofA is right about three hikes or the market is right about one, the direction is no longer in question. The next Fed surprise, if there is one, will be tighter policy, not easier. For investors who spent the last two years positioning for rate relief, that requires a real adjustment in thinking. 

The Fed finished cutting. Now it is deciding how much further it needs to go in the other direction.