Jobs and rents could shape the Fed's 2027 path

The Federal Reserve's 2027 rate path could turn more hawkish if the labor market becomes a renewed source of inflationary pressure and rental price disinflation reverses, two risks Deutsche Bank said were plausible outcomes for next year.

Markets have recently moved to price a peak federal funds rate above 4.80%, equivalent to nearly 100 basis points more of rate hikes. Deutsche Bank's base case remains for 50 basis points more, with 25-basis-point increases at the December and March meetings. The bank said a total of 100 basis points was also plausible.

For a more aggressive outcome, Deutsche Bank said the Fed would likely need to conclude that some economic pain was necessary to bring inflation back to its target. The bank said officials are not currently at that point, while wage growth has ranged from continued moderation to stabilization.

The labor market could be one catalyst. There is early evidence that it has started to tighten more noticeably, with payroll gains exceeding the breakeven rate. The Kansas City Fed's labor-market momentum index also points to further tightening in coming months. If that coincides with an acceleration in wage growth, further upside to Fed pricing would be warranted, Deutsche Bank said.

Rent inflation is the other risk. Year-over-year primary rent growth, which peaked near 9% in 2023, has slowed toward 2.75%. But there is early evidence from private-sector estimates that rental price inflation has started to drift higher. Deutsche Bank said the lead from those estimates to official data can vary, but they suggest CPI and PCE rental inflation are likely to firm next year, at least at the margin.

If both risks materialize, the probability of more Fed tightening than 75-100 basis points in total would rise considerably, Deutsche Bank said.