Fed Pivot Delayed: Strong Growth and Balance Sheet Debates Cloud Rate Path

The narrative of an imminent Federal Reserve pivot has unravelled abruptly. Following a string of robust economic data, markets have largely abandoned hopes for a rate cut in the first quarter, with consensus now shifting toward the central bank maintaining current policy settings potentially through the remainder of Chair Jerome Powell's term in May.

Key Data Snapshots

• US GDP growth projected at 2.8%, significantly above Fed's 1.8% estimate.
• PCE inflation expected to stay above 2% target through 2028.
• Fed Balance Sheet remains at approx $6.6 trillion.
• Potential cuts: 50 basis points forecasted late in the year.

Growth Trumps Easing

The catalyst for this hawkish repricing is the undeniable resilience of the US economy. A revised outlook from Oxford Economics projects US GDP growth to hit 2.8% this year, significantly outperforming the Fed's own non-inflationary growth estimate of 1.8%.

“We expect very strong growth to continue into 2026,” note analysts at Oxford Economics, citing AI investment and fiscal stimulus as key drivers. This economic heat is keeping inflation expectations sticky, with the PCE price index projected to remain above the Fed's 2% target through 2028. Consequently, 58% of economists surveyed by Reuters now expect no change in rates this quarter.

The Independence Battle

However, the path forward is complicated by unprecedented political volatility. Reports indicate escalating tension between the White House and the Federal Reserve, with speculations of Justice Department scrutiny over administrative matters at the Fed. Presidential criticism regarding the pace of easing has intensified, raising concerns about institutional independence as the search for Powell's successor accelerates.

Nomura's Senior US Economist Jeremy Schwartz suggests the Fed may attempt to “stay the course” to avoid appearing politically swayed, though he notes a leadership change later in the year could trigger a rapid policy shift, potentially delivering 50 basis points of cuts once new leadership is installed.

The $6.6 Trillion Question

Beyond rates, a critical debate is emerging regarding the Fed's $6.6 trillion balance sheet. As the central bank navigates liquidity demands, the choice of the next Chair will determine whether the Fed continues to shrink its portfolio (Quantitative Tightening) or stabilizes it to prevent money market turbulence.

Kevin Warsh, a leading contender for the Chairmanship, has advocated for a significantly smaller balance sheet, arguing that previous bond-buying programs distorted market signals. Conversely, other potential candidates like BlackRock's Rick Rieder caution that aggressive tightening could destabilize the financial system.