Inflation Genie Has Been Let Out of the Bottle, BMO’s Davis Says

Earl Davis of BMO Global Asset Management said rate hikes are not expected in 2026 but are likely back on the table in 2027, while the Federal Reserve could drop its easing bias within two meetings. He expects markets to refocus on inflation in the fourth quarter, keeping the rate path and yield outlook in focus. The comments are market-wide relevant because they imply a potentially less dovish Fed stance over the next several meetings.

Analysis

The market’s real vulnerability is not the policy rate path itself, but the sequencing of expectations. If inflation re-enters focus in the next few months, front-end yields can reprice faster than the Fed actually changes language, which tends to hit duration-heavy assets first: long-end Treasuries, leveraged REITs, and high-multiple growth equities. The second-order effect is that volatility in rates can remain elevated even in a “no hike” regime, because investors are forced to continuously re-anchor the terminal policy path further out.

A delayed turn toward a more hawkish bias would likely benefit cash-rich financials and money-market-adjacent businesses relative to rate-sensitive sectors. Banks with strong deposit franchises should hold up better than mortgage originators and housing-linked names, while commodity exposures can also see support if higher-for-longer policy keeps the dollar firm and financial conditions tight. The more subtle loser is credit: if inflation data stay sticky, spreads can widen even without a change in the policy rate, especially in lower-quality cyclical credits and private-market refinance names.

The contrarian read is that markets may already be partially priced for a slower easing cycle, but not for a regime shift in tone. The bigger risk is not a hike in 2026; it is a 2025 mini-repricing that pushes implied cuts out and lifts real yields by 25-50 bps, enough to pressure risk assets without any actual Fed action. That makes the next two meetings a catalyst window rather than a long-horizon macro call: if the Fed drops its easing bias sooner than expected, the move in rates could be abrupt and broad, but if inflation rolls over, duration should reassert quickly.

Key Decisions for Investors

• Go tactical short duration via TLT or IEF puts for the next 4-8 weeks; favor defined-risk options over outright shorts because the asymmetry is better if inflation data surprise hot and the Fed turns less dovish.
• Relative value: long XLF / short IYR for 1-3 months. Banks should outperform rate-sensitive real estate if front-end yields back up 25-50 bps; downside is a clean inflation miss that restores easing expectations.
• Add a small short in HYG or JNK against a long cash proxy. Credit spreads often widen before equities when policy tone shifts hawkish, offering 2-3x better convexity than shorting the index directly.
• If inflation prints remain firm, rotate into high-quality value and financials versus long-duration growth; pair long BRK.B or JPM against short QQQ for a 2-3 month tactical expression with limited beta risk.
• Set a trigger to fade any sharp rally in duration if the Fed explicitly removes easing bias; the trade is strongest on the first reaction, with potential 1-1.5 points downside in intermediate Treasuries from a language shift alone.