The market's expectation of significant Fed rate cuts is historically unfounded given current economic strength. With nominal GDP tracking so high, any rate cuts would likely fuel further nominal growth (either real growth or inflation), putting upward pressure on long-term interest rates and making duration risk in bonds dangerous.

Despite progress on shelter inflation, core services excluding shelter (the "super core") remain sticky. This persistence, linked to wage components, is a primary reason the Federal Reserve will likely pursue a gradual pace of interest rate cuts rather than a more aggressive easing policy.

The Federal Reserve is forced into a hawkish, inflation-fighting stance because the labor market and stock market are strong while inflation remains above target. This situation removes any justification for easing policy, making inflation the sole focus.

Even if US inflation remains stubbornly high, the US dollar's potential to appreciate is capped by the Federal Reserve's asymmetric reaction function. The Fed is operating under a risk management framework where it is more inclined to ease on economic weakness than to react hawkishly to firm inflation, limiting terminal rate repricing.

The US economy is showing stagflationary characteristics. GDP growth is weakening and projected to remain soft, while key inflation measures like PCE are nearly double the Fed's 2% target. This toxic mix limits the Federal Reserve's ability to support the economy without worsening price pressures.

The economy's resilience to rate hikes suggests the Fed's estimate of the neutral rate (R-star) is too low. The current model is overly influenced by the "extraordinary period" after the 2008 financial crisis. The true neutral nominal rate is likely closer to 4%, meaning current policy is still accommodative.

Every day the Federal Reserve fails to hike rates, it is effectively easing monetary policy. This inaction allows already loose financial conditions to continue stimulating the economy, creating significant inflationary pressure and pushing the Fed further behind the curve.

The textbook response to supply-shock inflation is to "look through" it and hold rates. However, one expert argues that after five years of high inflation, the sheer duration creates a risk of it becoming embedded. This "duration risk" could override the cause, forcing the Fed to tighten policy as a risk management measure.

The longevity of above-target inflation is a primary concern for the Fed because it can fundamentally alter consumer and business behavior. Historical models based on low-inflation periods become less reliable. Businesses report being surprised that consumers are still accepting price increases, suggesting pricing power and inflation expectations may be stickier than anticipated.