ABN AMRO expects the Federal Reserve to deliver 75 bps of rate cuts this year. It also forecasts policy moving towards a 3.00% Federal Funds Rate by year-end, despite inflation remaining above target.
The report says a Kevin Warsh-led Fed would use a “conviction-based” approach. It adds that this could involve less transparency, with reduced communication and guidance from FOMC officials.
Fed Reaction Function Shift
ABN AMRO states it expects more rate cuts than current market pricing implies. It links this to a more dovish Fed reaction function seen over the past half year, where inflation above target is given less weight than possible risks to employment.
With the current median Summary of Economic Projections, the note says there is scope to keep easing in 25 bps steps. However, its base case of stronger inflation is expected to limit near-term easing, while still pointing to a policy rate near 3.00% by year-end.
The Federal Reserve is signaling a clear preference for protecting employment over fighting every last bit of inflation. This means we should expect more interest rate cuts than the market is currently pricing in for the rest of the year. The Fed’s policy under Chair Warsh is guided more by conviction than by communicating every move in advance.
This stance is being tested right now, as January’s CPI report showed inflation is still sticky at 3.2%, well above the target. However, with the latest jobs report showing the unemployment rate ticking up to 4.1%, the Fed’s focus is clearly on the labor market. We believe this reinforces their dovish bias, making rate cuts in the coming months more likely.
Trading Implications
For derivatives traders, this points to positioning for lower short-term rates. Futures contracts for the second half of 2026, such as those for the Secured Overnight Financing Rate (SOFR), appear to be under-pricing the potential for cuts. Going long these contracts could be a way to capitalize on the Fed’s dovish path.
The new policy style of less guidance also means we should anticipate more market volatility around FOMC meetings. After a period of relative calm, buying options like straddles on major indices or bond ETFs before policy announcements could prove profitable. This strategy benefits from a significant price move in either direction, which is more likely when the Fed is intentionally less predictable.
We are also watching the yield curve for steepening opportunities. As the Fed cuts short-term rates, longer-term yields may not fall as quickly due to the persistent inflation and a reasonably strong economic outlook. This setup favors trades that profit from the widening gap between 2-year and 10-year Treasury yields.
This dovish reaction function is not new, as we saw it begin to emerge throughout the latter half of 2025. During that time, officials consistently downplayed strong inflation prints while highlighting any signs of weakness in employment data. That pattern appears to be solidifying into the core policy for 2026.
