Philadelphia Fed's Paulson Signals Rate Cuts Coming 'Later in 2026' as Inflation Nears Target

Philadelphia Federal Reserve President Anna Paulson delivered a carefully calibrated message on monetary policy Wednesday, signaling that while additional interest rate cuts are likely appropriate this year, patience is warranted as policymakers wait for clearer signals on inflation and economic growth. Her comments mark the first major policy address of 2026 from a Fed official who gains voting power on the interest-rate setting committee this year.

Speaking at the Allied Social Science Associations Annual Meeting, Paulson characterized her inflation outlook as one of "cautious optimism," suggesting a decent probability that underlying price pressures will reach the Fed's 2% target on a run-rate basis by year-end. However, she emphasized that the path forward remains uncertain and the timing of any rate adjustments will depend on incoming data.

Parsing the Fed's Dual Mandate

Paulson's remarks reflected the complex balancing act confronting monetary policymakers. On one hand, inflation has decelerated meaningfully from its 2022 peaks, with key measures now running in the 2.5-3% range—within striking distance of the 2% target. On the other hand, the labor market shows signs of cooling that could accelerate if policy remains too restrictive for too long.

"I see inflation moderating, the labor market stabilizing, and growth coming in around 2% this year. If all of that happens, then some modest further adjustments to the funds rate would likely be appropriate later in the year."

— Anna Paulson, President and CEO, Federal Reserve Bank of Philadelphia

The phrase "modest further adjustments" suggests Paulson envisions gradual rather than aggressive easing—a contrast to some market participants who had hoped for more dramatic rate relief. Her emphasis on "later in the year" pushes back against expectations for near-term action, aligning with consensus forecasts for the first cut coming in April or later.

Key elements of Paulson's economic assessment:

• Inflation outlook: "Cautious optimism" that three-month inflation will reach 2% by year-end
• GDP growth forecast: Approximately 2% for 2026, slightly below trend
• Labor market view: "Bending but not breaking"—cooling without collapsing
• Policy stance: Current rates are "still a little restrictive"

The Waiting Game

Paulson introduced "waiting for clarity" as her theme for output and employment in 2026—an acknowledgment that the economy is sending mixed signals that defy easy interpretation. GDP growth has been remarkably strong, with third-quarter expansion coming in at an above-trend 4.3%. Yet this robust headline masks troubling patterns in the labor market.

Nearly 90% of net private job creation through November 2025 occurred in a single sector: healthcare and social assistance. Stripping out that anomaly reveals an economy where hiring outside essential services has essentially stalled. The concentration raises questions about whether aggregate employment figures accurately capture labor market health.

Housing inflation, which proved stubbornly persistent through 2024, has finally begun to normalize. Owner's equivalent rent—the largest component of shelter costs—declined from 5.1% to 3.7% over the past year. If that trend continues, a major source of inflationary pressure will have been neutralized.

Policy Implications for Markets

Paulson's comments support the market's current pricing of Fed policy, which anticipates two rate cuts in 2026—one around April and another in September. The CME FedWatch tool shows approximately 70% probability of at least one cut by midyear, with the fed funds rate ending 2026 in the 3.00-3.25% range.

For bond investors, the message suggests duration risk may be limited. If the Fed proceeds gradually with cuts as Paulson indicated, long-term Treasury yields are unlikely to decline dramatically from current levels. The 10-year yield, trading near 4.2%, could remain range-bound as markets await confirmation of the inflation trajectory.

Equity investors may find comfort in Paulson's relatively sanguine economic assessment. A soft landing—where inflation returns to target without triggering recession—remains the Fed's base case and would support continued earnings growth. However, the acknowledgment that policy remains "a little restrictive" implies some drag on economic activity until cuts materialize.

A Contrast to Fed's Miran

Paulson's measured stance contrasts with more aggressive commentary from Fed Governor Stephen Miran, who earlier this week argued for rate cuts totaling "well over 100 basis points" in 2026. Miran contended that underlying inflation has already reached the Fed's target once measurement distortions are stripped out, and that current policy is unnecessarily restraining growth.

The divergence illustrates healthy debate within the Federal Reserve about the appropriate pace of normalization. Hawks worry that cutting too quickly could allow inflation to re-accelerate, while doves fear that maintaining restrictive policy too long could unnecessarily damage the labor market.

As a new voting member, Paulson's views will carry particular weight at FOMC meetings. Her moderate positioning—neither pushing for immediate cuts nor arguing for extended restrictive policy—suggests she may play a pivotal role in building consensus among policymakers with divergent views.

The Data Dependency Framework

Perhaps most importantly, Paulson emphasized the Fed's commitment to data dependency. Rather than following a predetermined rate path, policymakers will adjust their approach based on incoming economic information. Key reports to watch include:

• Friday's employment report: December payrolls will provide fresh labor market signals
• January CPI (mid-February): Next major inflation reading
• Q4 GDP (late January): Confirmation of economic momentum
• PCE inflation (late January): Fed's preferred price measure

Each report has the potential to shift rate expectations meaningfully. A surprisingly strong jobs number could push cut expectations further out, while soft inflation data might pull them forward. Investors should prepare for volatility around these releases.

What It Means for Borrowers

For Americans with variable-rate debt—including credit cards, adjustable-rate mortgages, and home equity lines—Paulson's message suggests relief is coming but not imminently. Those rates are tied to short-term benchmarks that track Fed policy, meaning borrowing costs will remain elevated until cuts actually occur.

Mortgage rates, which respond to both Fed policy and long-term bond yields, may see modest declines if economic data cooperates. However, the 30-year fixed rate is unlikely to return to the sub-4% levels of the pre-inflation era. Prospective homebuyers should budget for borrowing costs in the 5.5-6.5% range for the foreseeable future.

Savers, meanwhile, can continue to enjoy elevated returns on high-yield savings accounts and certificates of deposit. Many online banks still offer APYs above 4%, though rates will gradually decline as Fed cuts proceed. Locking in longer-term CDs at current rates may make sense for those confident they won't need the funds before maturity.

Looking to the January FOMC

The Federal Reserve's next policy meeting concludes January 28-29, just three weeks away. Market pricing overwhelmingly expects rates to remain unchanged at that gathering, with policymakers using the opportunity to assess year-end data and refine their forward guidance.

Paulson's remarks suggest she will support holding steady at the January meeting while keeping the door open for action later in the year. Her "cautious optimism" on inflation and acknowledgment that the labor market is "bending but not breaking" point to patience rather than urgency—a posture that appears to command broad support among Fed officials as 2026 begins.