Trends Matter, So Does Fed Credibility

The Federal Reserve (Fed) decided to raise rates by 25 basis points to the 3.75 - 4.00% range. Unlike July’s decision, this vote was unanimous.

Key takeaways

Warsh follows through with a much-anticipated hike. This was the first rate hike in three years and followed on the heels of the European Central Bank’s (ECB) decision last week to also raise rates. It was largely expected, with a probability of about 90% the day before the decision. Still, there were question marks about whether Fed Chair Warsh would actually vote for a hike given the significant pressure from US President Trump to cut rates. Warsh had been talking tough on inflation going into this, indicating a strong commitment to price stability. During the July Federal Open Market Committee (FOMC) press conference, he repeatedly pointed out that for more than five years, inflation was elevated and that was not acceptable. He said with this Fed, there is no “soft implicit target” for inflation. So, it likely would have seriously damaged his credibility if he had not voted for a hike this time around.

Warsh, the hawk. Warsh struck a hawkish tone, again emphasizing that inflation has been running above target for more than five years. He bluntly stated that inflation has been “too high” for “too long.” His rationale for the hike was threefold: 1) the economy had strengthened, 2) recent inflation readings remained elevated and were not trending towards the 2% target and 3) the geopolitical situation had worsened. Warsh characterized the decision to hike rates as removing “a dose of accommodation,” and when asked if he would now view rates as restrictive, he seemed to suggest they were still not.

“Trends matter.” Warsh stressed the focus on trends, not specific data points, which can be “noisy,” in his view. The FOMC statement was again short and simple and did not include forward guidance. Very little of the language in the statement changed; however, the Fed did articulate that it believes today’s rate hike would hasten the return to the Fed’s 2% inflation target.

Dot plot (minus one). As expected, the Fed released a dot plot with this decision (although for the second time, Chair Warsh did not participate in submitting dots):

• It showed that 16 out of 18 FOMC members believe at least one more rate hike would be appropriate for this year (four of those 16 believe two more rate hikes could be warranted)
• The Fed also lowered its forecasted unemployment rate to 4.1% for the next several years and for the longer run
• The Fed modestly raised forecasted inflation (core and headline) for 2026 but continues to expect a big drop in 2027

A measured press conference. In the press conference, Chair Warsh got several questions about how rate hikes can impact prices when they are being caused by supply shocks. He was specifically asked about how a 25 basis point rate hike could help inflation if the Strait of Hormuz remained closed. Warsh said the Fed can’t change individual prices but can prevent second and third order effects through monetary policy. When asked if he would need to weaken the labor market in order to bring inflation down, he said that was not necessary; he reiterated that he didn’t believe the Fed’s two mandates were at cross purposes. He was also asked what he thought the bond market was telling him with longer-term bond yields up a lot. He said yields have risen for three reasons: 1) the economy has strengthened, 2) stronger competition for capital (i.e., AI-related bond issuance) and 3) geopolitics causing price pressures.

DJT is watching. President Trump quickly reacted to the decision on social media, indicating his unhappiness with it:

“Interest Rates in the United States should be 1%, or less, because we are the Best Credit in the World — BY FAR. Our Country is BOOMING with new Investment! If we stopped Trading with every country that we have a Deficit with, which is most of them, we would make, at least, 1.5 Trillion Dollars a year. The word “Deficit” is nothing more than a fancy word for LOSS. We are “carrying” almost every country in the World, and that cannot go on any longer. LOWER THE INTEREST RATES FOR THE UNITED STATES OF AMERICA, AND FAST! President DONALD J. TRUMP.”

However, when asked by a reporter, Trump blamed the rest of the FOMC for the decision, explaining that he told Warsh he might as well vote yes with “the board” since it’s not going to matter since the board is “hostile and political.”

Market reaction, looking ahead

Equities sold off on the hawkish tone, and I anticipate continued pressure on stocks. The 30-year Treasury yield remained elevated, although slightly below the high it reached the day prior (Sept. 15^th). The 10-year Treasury yield remained near highs but finished the day slightly below 5%.

As I said after Warsh’s first two FOMC meetings, his new, less transparent approach – including the absence of forward guidance - is likely to result in more confusion and market volatility, in my view, at least in the near term. However, I think he definitely maintained credibility by hiking rates.

My base case in July was that the Fed would raise rates about two times this year, including at the September meeting. I continue to believe the Fed will likely hike rates one more time in 2026.

Figure 1. The September FOMC meeting dot plot (Summary of Economic Projections)