FED NOTE: The Neutral Trap
ZMacro Research – Institutional Edition
February 2026
Executive Thesis
The Federal Reserve has entered what can be described as the Neutral Trap regime:
- Inflation above target but declining
- Labor softening but stable
- Growth positive but slowing
- Policy mildly restrictive
The Fed Funds rate remains:
3.50–3.75%
After roughly:
175bp of cuts since 2024
The Fed is now transitioning from:
Disinflation regime → Equilibrium regime
The central bank is no longer attempting to crush inflation.
It is attempting to maintain equilibrium.
Part I — The Current Policy Regime
Policy Stance
Federal Reserve policy can currently be described as:
Mildly Restrictive Neutral
Key metrics:
Federal Funds Rate:
3.5–3.75%
Core PCE:
≈ 2.8–3.0%
Unemployment:
≈ 4.3–4.4%
GDP Growth:
≈ 2.3–2.4%
This is the classic late-cycle equilibrium configuration.
Part II — FOMC Policy Division
Doves
Christopher Waller
Key views:
- Inflation near target
- Labor weakening
- Cuts possible
Waller recently stated January jobs data could justify a pause but weakness would justify cuts.
Interpretation:
Waller is the pure macro-cycle dove.
He reacts primarily to labor deterioration.
Stephen Miran
Key views:
- Policy may be too tight
- Inflation not primary risk
Miran warned policymakers may be underestimating how restrictive policy is.
Interpretation:
Miran belongs to the liquidity-dove faction.
Bowman
Key framework:
- Inflation improving
- Labor fragile
Bowman historically aligned with easing faction.
Interpretation:
Bowman is a moderate dove.
Part III — Neutral Camp
Powell
Powell communication:
Policy well positioned.
Future cuts conditional.
Interpretation:
Powell is targeting:
Maximum optionality
John Williams
Williams framework:
- Inflation moderating
- Policy well positioned
- Soft landing possible
Interpretation:
Williams is the institutional consensus voice.
Jefferson
Jefferson framework:
- Supply disinflation
- Labor cooling
Interpretation:
Jefferson is a centrist technocrat.
Part IV — Structural Hawks
Raphael Bostic
Bostic introduced the most important structural argument:
AI may raise natural unemployment.
Rate cuts cannot fix structural unemployment.
Interpretation:
This is the most important Fed intellectual development since 2022.
The Fed is beginning to discuss:
Structural unemployment regimes.
Lisa Cook
Cook warned AI may increase unemployment short-term.
Interpretation:
Technology shock risk entering Fed framework.
Part V — FOMC Minutes Interpretation
Recent minutes indicate:
Inflation still above target.
Core PCE ≈ 3.0%.
Goods inflation rising due to tariffs.
Interpretation:
Fed cannot declare victory.
Part VI — Inflation Regime
Consumer Inflation
Recent CPI:
≈ 2.7%
Core CPI:
≈ 2.6%
Interpretation:
Inflation plateau.
Producer Inflation
Recent PPI:
0.5% monthly
2.9% annual
Core PPI:
3.6% annual
Interpretation:
Pipeline inflation persists.
Part VII — Labor Market Regime
Labor Stabilization
Unemployment:
≈ 4.3–4.4%
Interpretation:
Labor no longer tight.
But not weak.
Structural Unemployment Debate
Fed debate:
Cyclical View
Waller
Jefferson
Labor slowdown temporary.
Structural View
Bostic
Cook
AI raising natural unemployment.
Interpretation:
This debate will define 2026–2028 policy.
Part VIII — Growth Regime
Economic Expansion Continues
GDP forecast:
≈ 2.3–2.4%
Interpretation:
No recession baseline.
Part IX — Market vs Fed
Market Pricing
Markets expect:
Multiple cuts.
Fed View
Fed expects:
Limited cuts.
One cut possible.
Part X — Fed Reaction Function
Primary Variables
Fed policy depends on:
Variable 1 — Core PCE
Trigger level:
2.5%
Current:
≈3.0%
Variable 2 — Unemployment
Trigger:
4.7–5%
Current:
≈4.3%
Variable 3 — Financial Conditions
Key metrics:
- Credit spreads
- Equity volatility
- Treasury yields
Part XI — Hidden Fed Strategy
Fed objective:
Phase 1
Disinflation
Completed.
Phase 2
Equilibrium.
Current.
Phase 3
Late-cycle easing.
Future.
Part XII — Yield Curve Implications
Neutral regime historically produces:
- Range trading
- Slow bull steepening
Most sensitive sector:
2Y–5Y sector
Part XIII — The True Risk
The biggest risk:
Fed mis-estimates neutral.
If neutral higher:
Inflation returns.
If neutral lower:
Recession.
Part XIV — The Powell Legacy
Powell’s legacy will be:
Engineering:
Soft landing without crisis.
Part XV — Strategic Macro View
Base Case
Fed on hold.
Slow cuts.
Range markets.
Bull Case
Inflation collapses.
Fast cuts.
Bond rally.
Bear Case
Inflation returns.
No cuts.
Higher yields.
Final Assessment
The Federal Reserve is no longer:
An inflation fighter.
It is now:
A stability manager.
This is the most dangerous regime for macro traders.
Because:
- No clear trend
- No clear easing
- No clear tightening
Only:
Policy inertia.
