Kyle Reidhead predicts Fed rate cut as 50% of traders see hike

The Federal Reserve faces a deepening divide between market pricing and a contrarian view that inflation will fade as the U.S. economy shifts into what macro strategist Kyle Reidhead calls a deflationary environment, challenging the consensus that the next move is a hike.

"While Wall Street is pricing in a high probability that the Fed will hike interest rates, I see the opposite — inflation will fade as the U.S. adopts what I consider a deflationary environment," Reidhead said.

The fed funds rate has sat at 5.25% to 5.50% since the central bank's last 25-basis-point cut in September 2024. Consumer prices are rising at an annual pace of roughly 4%, double the Fed's 2% target, largely because energy costs have surged. Yet the labor market is cooling: U.S. employers added just 57,000 jobs in June, down from 148,000 in May, according to the Bureau of Labor Statistics. Kalshi traders see roughly 50% odds of a rate hike in 2026, while CME FedWatch data shows about a 1-in-4 chance of a move at the July 28-29 meeting.

If Reidhead's deflation thesis proves correct, it would upend the rate path priced into bond and equity markets, potentially driving the 10-year Treasury yield — currently above its 10-year average — sharply lower and reigniting risk appetite. If inflation stays sticky, the Fed's next move could be a hike, a scenario nine of 18 Fed governors projected at the June FOMC meeting.

The split in outlook reflects what Fed officials themselves described as "considerable uncertainty" in the minutes of their mid-June meeting. Almost all 19 members of the Federal Open Market Committee agreed they should raise rates if prices keep rising, but also agreed they could hold flat or even cut if inflation cools, according to the minutes released Wednesday.

"The FOMC remains genuinely conflicted and uncertain about the best next step for policy," Oliver Allen, senior U.S. economist at Pantheon Macroeconomics, wrote in a note.

Why a Cut Could Happen

Reidhead's argument rests on the idea that the inflationary effects of tariffs and energy price spikes will prove transitory. The Fed's own minutes acknowledged that inflation "could begin to decline as the effects of tariffs and energy price increases wane." If that happens, almost all Fed officials said it could be appropriate "to maintain or eventually lower" interest rates.

The last time the Fed used similarly conditional language was in late 2023, preceding a pivot to rate cuts in September 2024. The S&P 500 rallied 23% in the 12 months following that first cut, while the 2-year yield fell 150 basis points.

Newmark research examining data from 1990 to 2023 found that commercial real estate returns averaged just 3% over the three years following a rate cut, compared with 8.3% during periods when rates held steady — a reminder that cuts typically coincide with economic deterioration. But for equity and bond investors, the initial relief rally has historically been significant.

The Hike Scenario

Inflation risks remain tilted to the upside. Fed officials flagged concerns that supply disruptions "could persist longer than currently anticipated" and that the boom in data center construction and other AI-related investments could "contribute to more persistent inflationary pressures," the June minutes showed.

Markets dialed up rate hike expectations after Fed Chair Kevin Warsh emphasized the central bank's "unanimous and unambiguous" commitment to returning inflation to 2%. Nine of 18 Fed governors project at least one hike this year, while eight expect rates to remain flat.

"Inflation has become the dominant concern at the central bank," Bernard Yaros, lead U.S. economist at Oxford Economics, wrote.

The next test comes with updated inflation data due next week, which will give markets more clarity on whether a July hike is on the table. Ian Lyngen, head of U.S. rates strategy at BMO Capital Markets, said that outside the initial spike in energy costs, overall inflation has been "relatively well contained," making a near-term hike less likely.

For investors, the divergence between Reidhead's deflation call and the consensus hike view creates a binary risk. If inflation data surprises to the downside, bond yields could fall sharply and growth-sensitive sectors could rally. If inflation reaccelerates, the opposite trade applies — and the Fed's next move would be a hike, not a cut.

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