Inflation Deviates from Five Years and Policy Paradigm Shift: Why the Federal Reserve Finds It Difficult to Return to the 2% Era

June 17, 2026, the Federal Open Market Committee (FOMC) unanimously decided to keep the federal funds rate target range unchanged at 3.50% to 3.75%. This marks the fourth consecutive pause since the last rate cut in December 2025. The rate itself did not become the market’s focus—what truly sparked widespread discussion was a deeper fact revealed by the simultaneously released economic projections summary and dot plot: inflation has been deviating from the 2% target for over five years, and the median forecast for core PCE inflation at the end of 2026 was sharply raised from 2.7% in March to 3.3%.

Five years. Since inflation surged rapidly in 2021 to reach its highest levels in about four decades, the Federal Reserve’s policy path has undergone a complete cycle—from a judgment of “transitory” to aggressive rate hikes, and then from inflation receding to a secondary rebound. However, by mid-2026, not only has the 2% inflation target not been restored, but it also seems increasingly distant in the foreseeable future. This article aims to answer a core question: why can’t the Fed return to the 2% target era? The answer must be explored across three levels: the logic behind the upward revision of inflation forecasts, the fundamental shift in the Fed’s policy framework, and the structural characteristics of supply shocks.

A policy meeting redefined by “hawkishness”

The policy statement from the June FOMC meeting was only 130 words, the shortest in 19 years. It removed all suggestive language about future rate adjustments and fully downplayed the forward guidance that had been the communication cornerstone during Powell’s era. New Chair Kevin Waugh explicitly stated at his first press conference that the Fed has abandoned forward guidance and cannot provide any forward-looking signals about future actions. He likened the dot plot to “a pencil with an eraser,” emphasizing that colleagues understand the world is changing rapidly and will not be bound by views from six weeks ago.

Behind this paradigm shift in communication is a substantial deterioration in inflation forecasts. The overall PCE inflation forecast for 2026 was raised from 2.7% in the March SEP to 3.6%, and core PCE from 2.7% to 3.3%. The forecast for 2027 was also revised upward—core PCE from 2.2% to 2.5%. Notably, the dot plot shows that among 18 officials submitting forecasts, 9 expect at least one rate hike before the end of 2026, with 6 advocating for a cumulative increase of 50 basis points or more. In contrast, in the March forecast three months earlier, no one anticipated rate hikes within the year. The median federal funds rate expectation for the end of 2026 was raised from 3.4% to 3.8%.

What does this mean? In just three months, the consensus within the Fed on the rate path has shifted from “one rate cut this year” to “one or more rate hikes.” The only variable driving this reversal is inflation.

Structural roots of inflation deviation

The failure of inflation to return to 2% for five consecutive years is not due to a single event but results from a series of structural factors stacking up.

The first factor is geopolitical shocks causing energy price volatility. The Iran conflict pushed up global energy prices, and although recent peace prospects between the US and Iran have caused oil prices to retreat, the lagged effects on inflation remain significant. In May, US consumer prices rose 4.2% year-over-year, surpassing 4% for the first time in three years, marking the fastest increase since May 2023. The Fed’s statement explicitly pointed out that part of the inflation reflects supply shocks driving up prices in energy and other sectors.

The second factor is the inflation pass-through from tariff policies. Tariffs implemented by President Trump have put upward pressure on import prices. Unlike energy shocks, tariffs have a more persistent impact on inflation—they directly alter the relative prices of imported goods, and adjustments are often not one-off.

The third factor stems from domestic structural demand. The AI boom has driven data center construction, increased electricity demand, and sustained capital expenditure, compounded by wealth effects from stock market gains, increasingly viewed by policymakers as a new short-term inflation source. In May, retail sales rose 0.9% month-over-month, well above expectations, with year-over-year growth reaching 6.9%, the highest in nearly three and a half years. The resilience of consumer demand means that even if energy prices fall back, demand-side inflation pressures continue to build.

The fourth factor is the price stickiness of core services. Bank of America economists noted that the inflation decline driven by housing factors has essentially ended, and prices for other core services remain quite sticky. This means that even if goods inflation recedes due to supply recovery, the structural nature of service inflation will keep core PCE above the target.

The China Merchants Bank Research Institute pointed out that productivity growth and capital investment are strong, but inflation deviation has persisted for over five years. Waugh admitted at the press conference that sustained high prices burden the American people. But the key issue is that the Fed cannot significantly influence specific prices—such as energy or supply shocks—its main job is to prevent “second-round effects” on inflation expectations. This statement clearly defines the policy anchor of the Waugh era: not directly fighting supply shocks, but preventing inflation expectations from unanchoring.

From “forward guidance” to “data dependence”: a fundamental shift in the policy framework

The first FOMC meeting under Waugh’s leadership carries a significance that may surpass the rate decision itself.

He announced the establishment of five special working groups, covering communication mechanisms, balance sheet management, macro data sources and data dependence systems, productivity and labor market research, and inflation policy frameworks and new technology impacts. These groups plan to complete comprehensive reviews and submit reports by the end of the year. This marks the largest reform of the Fed’s policy framework since the 2008 financial crisis.

Waugh’s criticism of the current data system is noteworthy. He pointed out that most of the data relied upon by the Fed come from “outdated survey methods,” which are ill-suited to reflect the economy of 2026. Response rates are inadequate, and the questions may have been relevant a generation ago but are less so now. He even expressed openness to incorporating real-time data from private enterprises and emphasized that financial market prices are the most important information guiding central bank decisions.

What does this imply? The Fed under Waugh is shifting from “managing market expectations” to “relying on real-time data and economic realities.” The logic behind abandoning forward guidance is that markets perform best when reacting to real-time data; market prices themselves are the most critical reference. If markets merely reflect what the Fed says, it’s equivalent to “taking away the most important information source and ignoring it.”

For inflation management, this shift has profound implications. During Powell’s era, the Fed used forward guidance to anchor market expectations of the rate path, influencing financial conditions and indirectly affecting inflation. Waugh’s logic is: rather than guessing what the Fed thinks, it’s better for the Fed to observe market price signals. This “market-based” decision philosophy means future policy adjustments will rely more on real-time data, be more unpredictable, but potentially more precise.

Market repricing and rate hike path projection

The hawkish signals from the Fed have been quickly priced into the market.

Interest rate futures markets experienced dramatic re-pricing before and after the meeting. Implied probability of a rate hike in September was only about 27% before the meeting, soaring to about 83% afterward; by the October meeting, a hike was fully priced in, with expectations of a total increase of about 155 basis points before year-end. The two-year Treasury yield jumped about 12 basis points in a single day, the largest daily increase since April 2025.

Meanwhile, different institutions’ views on the rate hike path diverged significantly. Deutsche Bank expects a total 50 basis point increase in 2026, with rates rising to 4.1%, possibly bringing forward the July hike. Bank of America, on June 22, reversed its previous stance, now expecting three rate hikes within the year, totaling 75 basis points, with a July hike “within the realm of possibility.” Bank of America economist Aditya Bave bluntly stated: “The Fed’s inflation problem has clearly worsened.”

However, the implementation of rate hikes remains uncertain. A report from Donghai Securities pointed out that the main driver of expected hikes is the rise in oil prices and its inflationary impact. With the US and Iran having signed an agreement, if subsequent oil price trends decline and the impact on inflation diminishes, expectations of rate hikes this year could retreat. Fed officials like Goolsbee also said the Fed needs to assess whether temporary shocks like tariffs or Iran’s conflict causing energy prices to spike are the sole reasons for inflation increases.

For the cryptocurrency market, rising rate hike expectations mean liquidity conditions will continue to tighten. When markets start trading “longer periods of high rates” or “another hike,” the key concern shifts from geopolitical events to whether new sources of liquidity will emerge. In a macro environment where expectations of rate cuts have sharply diminished and funding remains under pressure, risk assets face more severe valuation challenges in the short term.

Conclusion: The distance to the 2% target

Returning to the core question of this article: why can’t the Fed return to the 2% target era?

The answer is not singular. Repeated supply shocks, the inflationary effects of tariffs, structural demand resilience, and the price stickiness of core services all form systemic barriers to inflation returning to the target. Meanwhile, the Fed’s own policy framework is undergoing profound change—from reliance on forward guidance to a return to data dependence, from managing expectations to observing markets. This shift itself is redefining what “inflation management” means.

Waugh emphasized at the press conference that the 2% inflation target is not within the scope of the working groups’ research, and there is no reason to revisit the target until it is achieved. However, with the 2026 core PCE forecast already raised to 3.3%, and the 2027 core PCE forecast still at 2.5%, markets have reason to question: after five years of persistent deviation, is 2% truly an achievable goal, or just a delayed promise?

The answer may depend on the evolution of three variables: whether Middle Eastern tensions can truly ease and bring energy prices back to normal; whether the inflationary effects of tariffs will persist over a longer period; and whether, under Waugh’s leadership, the Fed can find a more effective inflation management path than “higher for longer” through institutional innovation. Until then, 2% may remain a goal worth pursuing but difficult to reach.