The Fed’s Rate Hike

Estimated reading time: 5 minutes

No Choice But to Hike

Well, we were wrong. we thought the Fed wouldn’t hike interest rates. But we still believe a hiking cycle could do more harm than good. 

Regardless, what I’m focused on now is that the Federal Open Market Committee voted unanimously to raise the target rate by 25 basis points to a range of 3.75%-4.0%. Here’s what we think that could mean for future rate hikes and the economy at large. 

Chairman Kevin Warsh’s tone during the press conference today was consistent with his speech at Jackson Hole in late August. He’s concerned about high inflation and focused on the Fed’s responsibility to return inflation to its 2% target.

As usual, markets were a bit jumpy while he spoke, but ultimately interpreted his comments as hawkish. 

The words that seemed to have the most impact were “we removed a dose of accommodation.” There are two implicit meanings in that phrase: 1) The Fed has been too lax about keeping inflation in check, and 2) In order to bring inflation down, the fed funds rate needs to rein the economy in more. In other words, more hikes are coming.

Treasury yields have been the loudest message from markets recently, with the 10-year Treasury yield crossing 5% for the first time since 2023 and the 2-year yield also climbing. In reaction to the rate hike and Warsh’s comments, Treasury yields rose yet again on the expectation that this was the first in a series of hikes. In other words, yields are saying 25 basis points wasn’t enough.

By the end of the trading session, markets had priced in a second rate hike in 2026, and two more in 2027. 

Future Feelings

What helps us understand the Fed’s decision is the latest summary of economic projections and dot plot, also released today. As the chart below shows, the Fed’s new projections for the rest of 2026 show stronger GDP growth, lower unemployment, and higher inflation than it expected in June. As a result, projections for the fed funds rate also rose.

The upshot: The Fed believes the economy can withstand a number of rate hikes.

Although the stock market’s immediate reaction was negative, let’s see what happens in the coming days. If the message from markets is that this rate move was a mistake, the question becomes: A mistake because they shouldn’t have hiked, or because they didn’t hike enough?

What’s Next

We completely understand the Fed’s reasons for hiking, and given their mandate of stable prices, we also understand that not hiking rates might have hurt their credibility and been difficult to defend. 

However, our concerns about what the future holds stand. Rate hikes are a blunt object that cannot be directed at specific parts of the economy. The main drivers of inflation today – wartime oil prices and insatiable demand for AI – are not going to be affected by these rate hikes, but other parts of the economy will be affected, and perhaps not in a good way. 

Most central banks face the same challenge: pinpointing when to stop a hiking cycle. History has shown it’s very difficult to get that right, and we fear this time will be no different.

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