Rapid Response - Federal Reserve raises rates in the first move since last December's cut
Today, the Federal Reserve raised interest rates by a quarter point to the 3.75% - 4.00% range, as widely expected, and signalled that another will likely follow. However, the FOMC was reluctant to align with market views that more rate hikes will be required in 2027.
The Committee raised the target range for the federal funds rate by +0.25% to 3.75% - 4.00% by a unanimous 12–0 vote, with no dissents (July’s hold was a 9-3 vote).
Against July, the growth paragraph was rewritten to drop the specific reference to "the conflict in the Middle East" in favour of the broader "uncertainty remains elevated owing, in part, to geopolitical developments, domestic spending has been resilient".
The productivity growth assessment remained as “strong”, as capital investment was upgraded from "strong" to "robust".
The line on the labour market remained as "Job gains have kept pace with the workforce, and the unemployment rate has changed little”.
The inflation language was materially tightened: July's qualifier attributing elevated inflation "in part reflecting supply shocks that have driven price increases in certain sectors, including energy" was deleted, leaving the unadorned "Inflation remains elevated," followed by the new sentence "Today's policy action will support a timelier return to the Committee's 2 percent goal," while the standing commitment "The Committee will deliver price stability" was retained verbatim.
In the press conference, Chair Warsh framed the move as removing accommodation rather than restricting: "As I said at the policy symposium in Jackson Hole, I would be hard-pressed to describe broad financial conditions as restrictive. This view was widely shared by the Committee. So we removed a dose of accommodation".
On inflation he was blunt: "The plain fact is that inflation is too high and has been for too long," adding "This summer's inflation readings do not tell me that underlying trends have meaningfully improved," and estimating from recent CPI and PPI data that total PCE prices likely rose around 3.6 percent in the 12 months to August, with too many categories still posting increases above 3 percent on both a 6- and 12-month basis.
Consistent with his stated communication strategy, Warsh again declined to offer forward guidance and would not prejudge the next meeting; asked directly whether he had a message for President Trump, he chuckled and replied, "I've got nothing for you on a discussion with the president".
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US 2yr 4.74% +7bps, US 10yr 5.02% +2bps U
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Fin-X View
Today’s rate increase was widely anticipated following last week’s inflation data, and the dot plots indicate that the majority of the FOMC sees one more rate increase before the end of the year, in line with market pricing. Another hike is also implied by Chair Warsh's comments that today's increase merely removed some of the accommodation.
The timing of the rate increase is more likely to be in December rather than at the end of October, as the Fed is assumed to avoid hiking just before the midterm elections.
What happens beyond the end of 2026 is very much in doubt, with the dispersion in projections increasing materially. Moreover, PCE inflation is not expected to return to target until 2029, at odds with the chairman's claim that today's hike would result in a “timelier” return.
The market is almost fully pricing another three rate hikes by the end of next year. None of the FOMC projects so many, with a few expecting rates to be cut. The majority expects rates to end next year one quarter point higher, which is half a percentage point above the last published projections in June, but still half a point shy of the market.
The median projections suggest that rates will be held higher for longer though. Members expect a 2029 rate of 3.6%, with longer-run estimates equivalent to a neutral rate still expected to be around 3.2% when inflation returns to target.
The Fed is faced with a very difficult situation. Chair Walsh acknowledged the role that supply constraints are playing in inflation. These seem likely to persist at least through to the end of 2026. But the AI boom is leading to very uneven demand, with some parts clearly more vulnerable to higher rates.
It's near impossible to gauge how the economy as a whole will respond as the rate increases start to work through next year. But the Committee’s projection, that inflation will gradually return to target while unemployment remains around 4.1% and GDP growth remaining above 2%, seems to be a low-probability scenario. Market pricing of more rate hikes and slower growth seems more plausible.
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