Could the Fed hike rates three times before year-end? The data says it's possible, and the market isn't prepared for it.
KEY TAKEAWAYS
A major Wall Street forecast shifted dramatically, with expectations moving from stable rates to three potential Fed hikes before year-end. The change reflects concerns about persistent inflation and stronger-than-expected economic activity.
Recent Federal Reserve communication carried a noticeably more hawkish tone despite no immediate rate increase. The emphasis on price stability suggests inflation control remains the central priority.
Market pricing currently reflects a much more modest tightening path than some economists are forecasting. This creates the potential for investor surprise if inflation remains elevated.
Consumer spending remains resilient on the surface, but underlying financial conditions appear weaker. Savings rates have fallen sharply while credit card stress and delinquencies continue to rise.
Higher interest rates would create valuation pressure for growth-oriented sectors, particularly technology and artificial intelligence companies whose earnings expectations are concentrated in future years.
MY HOT TAKES
Risk management begins by examining adverse scenarios before focusing on upside potential. Ignoring tail risks has historically proven far more damaging than missing optimistic outcomes.
The market may be placing too much confidence in a benign monetary policy outcome. Hawkish risks appear materially larger than current futures pricing suggests.
Federal Reserve messaging matters as much as policy actions. Leadership tone and communication can reveal future intentions before any formal rate decision occurs.
The health of the consumer is a more important indicator than headline retail sales figures. Household balance sheets often reveal stress before it becomes visible in broader economic data.
Investors should pay closer attention to the relationship between interest rates and valuation multiples. Markets can overlook this connection for periods of time, but eventually the mathematics reassert themselves.
You can quote me: "Three Fed hikes are no longer a fringe forecast—they're a risk the market is actively choosing to ignore."
Don't look down, don't look up. I have about 20 to 30 minutes each morning to process the massive amounts of data I consume on a daily basis. My walk to the ferry terminal and my ferry ride–and to be fair, I am usually reading market commentary on my ferry ride, so really, it's more like 10 minutes. Those 10 minutes are usually dominated by perseverating on the "what can go wrong" theme. I know that may seem very pessimistic, though I am not a pessimist. In fact, I am an eternal optimist. But I am also a guy who has been doing this Wall Street thing for some 35 years, and my scars tell a story of the times that I forgot to go over the "what can go wrong" case. Those scars have taught me to think about the risks before I think about the expected return. It's just the way I do things.
Markets, though a bit shaky yesterday, are doing surprisingly well in a very unstable macro environment. I am a sailor, so I was taught to look for environmental signs. For example, we look at flags or ripples on the water surface for wind direction. Going with that analogy, when I look at the macro environment, I see a row of flags in the distance and all of them are pointing in different directions with some of them flapping violently in no discernible direction. Ok, that just means we need to be extra vigilant in these conditions. As such, I have lately found myself walking to the ferry terminal earlier than usual and with a quicker gait.
This morning was no different. I walked, perseverated, I waited in line on the dock, took my seat, then started to read some market notes. One immediately caught my eye. It was from Bank of America. The note, from BofA's Head of Economics, was from Monday, and in it he called for the Fed to hike three times before year-end–2026! Wait, what?? Fed Funds futures are predicting a high probability of one hike tops. Come to think of it, I did notice that yesterday morning's ADP Weekly NER Pulse (which I watch like a hawk) came in respectably strong. In fact the trend has been quite positive since late last year. Hmm. Is there any credence to BofA's call? Could this really happen? What can go wrong?
Let's start with what BofA actually said, because the specifics matter. Economist Aditya Bhave published his note on Monday and did not mince words. He called for three consecutive 25-basis-point hikes–in September, October, and December–that would lift the Fed Funds rate from its current 3.50%-3.75% range all the way to 4.25%-4.50% by year-end. That is a complete reversal from the position BofA held as recently as the prior week, when they expected rates to stay flat through 2026. The catalyst for the flip? The commentary cited what it called "unambiguously worse" inflation–core PCE could hit 3.5% in May, nearly 70 basis points higher than a year ago–combined with a labor market that has firmed up enough to remove any justification for staying easy. He also upgraded BofA's Q2 GDP tracking estimate to 2.8% annualized off a strong May Retail Sales print. In Bhave's words, the data calls for hikes. BofA now sees no rate cuts until 2028. That is a long time to live with tight money, and I think it is worth asking whether the economy, more specifically the American consumer, can actually survive that journey intact.
Now, I would not be doing my job if I did not give you my read on Warsh's body language, because I think that is where the real story was hiding last week and most of Wall Street missed it. Kevin Warsh held his first FOMC press conference on June 17th, and if you counted the number of times he invoked "price stability," you ran out of fingers. He told the room the FOMC's commitment to delivering price stability was, and I am quoting him directly here, "strong, unanimous, and unambiguous." He added that this was "an important message we've missed for five years" and pledged to fix it. He stripped forward guidance out of the policy statement entirely, called the new statement "curt," declined to submit his own dot to the dot plot, and announced five task forces to rethink how the Fed operates from the ground up. Most folks seemed to have interpreted all of that as a "hold," and relaxed. I heard something else entirely. One analytical tool trained on decades of Fed statements scored Warsh's June communication at plus 1.3 on a hawkish scale, which is a meaningful shift. The hawks did not need a rate hike that day. They needed a new sheriff to walk in and establish credibility, and that is exactly what Warsh did. The body language was loud, and to me, overt.
So do I buy BofA's call? I buy the direction. I am less certain about the pace. Three hikes is an aggressive path, and here is why I think the market, currently pricing roughly 36 basis points (based on Fed Funds futures) of tightening–call it one hike for sure and maybe a second–is not entirely wrong to push back on the magnitude. Warsh has made data dependency his religion. He eliminated forward guidance precisely so the Fed retains maximum optionality. That is not the behavior of a chair who has pre-committed to a hiking cycle. It is the behavior of someone who wants to react, not telegraph. One hike, possibly two, feels more consistent with that posture than three on a predetermined schedule. Where I part ways with the futures market is on the risk. One hike is priced in fairly confidently. Two is just shy of a coin flip (45%). Three is almost off the table in market pricing. I think that probability distribution understates the hawkish tail considerably. If you are positioned for a benign Fed and Bhave turns out to be even half right, that is a very uncomfortable surprise to absorb.
Here is the part of this story that keeps me walking faster to the ferry, though. The BofA thesis rests on a consumer and labor market that holds together long enough for the Fed to hike three times between now and December. I am not sure that foundation is as solid as the headline numbers suggest, and this is where my "what can go wrong" radar starts flashing. Let me give you the less obvious data that nobody is leading with. Yes, May retail sales came in at $763.7 billion, up 0.9% from April. Strong number. But the biggest driver was gasoline stations, up 3.4%--that is not consumer confidence, that is consumers paying more at the pump because of Iran. Strip out gas and sales still rose a solid 0.7%, but here is the context the headline hides: real disposable income in April was running 1% below where it was a year ago. The personal savings rate has collapsed to 2.6%, down from 6.2% in early 2024. The Millers (my fictitious average American family) are not spending because they feel wealthy. They are spending because they have no cushion left and the bills keep coming. You do not maintain a 2.6% savings rate indefinitely, especially when the credit card is already under stress. Total US credit card balances stood at $1.252 trillion as of the first quarter of 2026, and the serious delinquency rate–accounts 90 days or more past due–just hit 13.12%, a 15-year high. That number has not been that bad since the wreckage of the 2008 financial crisis. Total household debt sits at $18.8 trillion, with 4.8% of it in some stage of delinquency. The conveyor belt of cost-push pressure has been running for years, and the American consumer is getting tired of standing on it. Three rate hikes into this environment would not be Fed tightening–it would be kicking someone who is already on one knee.
And that brings me to what this means for your portfolio, specifically if you own growth stocks and technology names. The math here is not complicated, but the market keeps pretending it does not apply. When the risk-free rate goes up, the present value of future earnings goes down. That is not an opinion–it is arithmetic. Growth companies, particularly in technology and artificial intelligence, are valued on earnings streams that stretch years into the future. When you discount those streams at a higher rate, they are worth less today, full stop. The Nasdaq dropped 4.1% in a single session on June 5th on rate-hike fears, which was its worst day since April 2025. As of this morning, futures are pointing to another roughly 2% decline as that reassessment continues. Even with yesterday’s selloff, the Nasdaq is up 10% year to date. Those gains were built in an environment where rate cuts were on the menu. Now Bank of America–a respectable financial institution–is telling you the next move is three hikes. Even Goldman Sachs, which is not calling for hikes, has quietly pushed any rate cut expectations out to 2027. The rate backstop that the bull market has been leaning on has been quietly pulled out from under it. Markets have not fully processed that yet.
Here is my message for this morning. BofA may be too aggressive on the number–three hikes before December is a specific and ambitious path for a Fed chair who just told us he refuses to give forward guidance. But the direction is right, and the market is underpricing the risk. One hike is nearly certain in the futures market. Two is a reasonable bet. Three cannot be dismissed the way it was a month ago. What I would watch more closely than the Fed, however, is the consumer. The savings cushion is gone, the credit card is maxed and increasingly delinquent, and disposable income is shrinking in real terms even as the headline retail number looks fine. If the consumer cracks before the Fed gets to September, the data-dependent Warsh may find himself holding his hiking pen over a very different economic picture. And if the consumer holds long enough for three hikes to land…well, then the cracks come after. Either way, the era of the market being rescued by easy money is over. The flags are all pointing in different directions, and some of them are flapping very hard at the moment. Hold tightly on those sheets (ropes in a sailboat 😉), there is weather on the horizon.
YESTERDAY’S MARKETS
Equity markets closed lower Tuesday, with the S&P 500 falling 1.44% and the Nasdaq Composite dropping 2.21%, as a broad selloff in semiconductor and AI-related names dragged technology shares sharply lower. The Dow Jones Industrial Average was essentially flat, closing at 51,665, cushioned by gains in healthcare and defensive names. The 10-year Treasury yield held near 4.50%, remaining elevated in the wake of last week's hawkish FOMC meeting. WTI crude settled at $73 per barrel, continuing its decline as US-Iran peace talks advanced and tanker traffic through the Strait of Hormuz showed signs of recovery.
NEXT UP
New Home Sales (May) is expected to have increased by 3.2% after declining by -6.2% in April.
Fed Governor Lisa Cook will speak today.
Important earnings today: Paychex, Micron (very important), and Jefferies Financial.