Fed Signals More Rate Cuts on the Table Later This Year

Philadelphia Federal Reserve President Anna Paulson said additional, modest interest-rate cuts could be warranted later in 2026, provided the broader economic outlook continues to improve and inflation remains on a steady downward path.

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“I expect inflation to keep easing, the labor market to find its footing, and economic growth to come in around 2% this year,” Paulson said in prepared remarks scheduled for delivery Saturday at the American Economic Association’s annual meeting in Philadelphia. “If those conditions hold, then it would make sense to consider some limited further adjustments to the federal funds rate later in the year.”

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Paulson cautioned, however, that risks surrounding the labor market remain elevated. She pointed to a slowdown in hiring demand that has been stronger than the reduction in labor supply tied to the Trump administration’s stricter immigration policies. That imbalance, she suggested, could weigh on employment conditions if it persists.

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Still, there are signs of stabilization. Paulson noted that claims for unemployment benefits have leveled off in recent data, offering reassurance that the job market is cooling gradually rather than deteriorating rapidly. “The labor market is clearly bending,” she said, “but it is not breaking.”

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Despite the Federal Reserve’s recent round of rate cuts, Paulson said monetary policy remains somewhat restrictive. In her view, that restraint is still playing a useful role in pushing inflation lower.

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“The combined effect of past tightening and the current stance of policy should continue to apply downward pressure on inflation,” she said, adding that this approach is expected to guide price growth back toward the Fed’s 2% target over time.

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Paulson also addressed the impact of tariffs, acknowledging that higher import costs are likely to keep goods prices elevated through the first half of 2026. However, she expects those pressures to fade later in the year, allowing goods inflation to return to levels consistent with the central bank’s long-term objective.

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Within the Federal Reserve, officials remain split over how much additional easing is appropriate after cutting rates by a total of 75 basis points across their last three meetings. An increasing number of policymakers favor pausing further moves until they have clearer evidence on where inflation and employment are heading.

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Looking ahead to 2026, the median projection from Fed officials calls for a single quarter-point rate cut. Financial markets, by contrast, are pricing in expectations for at least two reductions, highlighting a growing gap between investor sentiment and policymaker caution.

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Federal Reserve officials are navigating a particularly complex economic landscape. The unemployment rate climbed to a four-year high of 4.6% in November, even as underlying inflation showed further improvement. At the same time, economic growth surprised to the upside, with data indicating the U.S. economy expanded at an annualized pace of 4.3% in the third quarter.

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That mixed backdrop has made policy decisions more challenging. Paulson noted that the recent federal government shutdown has disrupted data collection, making it harder to accurately assess economic conditions. As a result, she said interpreting the latest indicators requires extra care.

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Her current outlook which she emphasized does not yet incorporate the most recent unemployment figures reflects what she described as “cautious optimism” on inflation, paired with a desire for greater clarity around the forces driving strong growth alongside a softening labor market.

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Paulson reiterated earlier comments suggesting that artificial intelligence could eventually deliver a significant boost to productivity. If that scenario plays out, stronger growth would not necessarily translate into higher inflation, easing the trade-offs facing the Fed. However, she stressed that policymakers won’t be able to determine in real time whether faster growth is being driven by productivity gains or more inflationary forces.

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“That uncertainty makes policymaking especially difficult,” she said, underscoring the need for patience and flexibility as new data emerges.

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Earlier on Saturday, Paulson also presented an essay she co-authored highlighting the critical role of central bank credibility in controlling inflation surges. The paper argued that clear communication and consistent policy responses help anchor expectations, reducing the risk that temporary price shocks become entrenched.

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“It appears that the inflation experience of the past five years has not permanently altered long-term inflation expectations,” the essay concluded a finding that may offer reassurance to policymakers as they weigh their next steps.

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Taken together, Paulson’s remarks reflect a Federal Reserve that is open to further easing but firmly dependent on the data. While modest rate cuts later in 2026 remain on the table, officials appear determined to move carefully, balancing signs of cooling inflation against lingering labor market risks and an economy that continues to show surprising resilience.

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