As expected, the Federal Open Market Committee (“FOMC”) increased the fed funds target rate to 3.75% to 4.00%, with all voters in favor; this marks the first interest rate hike since 2023. The brief statement cited the commitment to the Fed’s dual mandate and acknowledged that while uncertainty remains, “domestic spending has been resilient.” The statement reiterated the 2% inflation goal and justified the decision based on both continued elevated inflation and a steady unemployment rate.
The Fed also updated its economic projections reflecting both the continued growth of the economy as well as the increased pricing pressures that precipitated the move. The FOMC anticipates GDP of +2.3% for 2026 and an acceleration to +2.4% in 2027, up from +2.2% and +2.3%, respectively. In addition, the unemployment rate is forecasted to settle at 4.1% both this year and next, down from 4.3% in June. Most importantly, core PCE was previously penciled in at +3.3% for 2026 and was marked up to +3.4% (a sharp increase over the March estimate of +2.7%), reflecting the upgraded growth forecasts, continued high energy prices, and the passthrough of AI-related capital expenditure to goods prices. As in June, the result was an increasingly hawkish dot plot, with rates now expected to close both 2026 AND 2027 at 4.1%, with the first hint of a cut coming in 2028. Perhaps more importantly, four respondents see upside to that 4.1% for 2027, implying that the Fed could be forced to do even more than anticipated in the first half of next year.
The press conference further amplified the narrative set forth in the projections, despite Fed Chair Kevin Warsh’s lack of participation in those projections. He framed the decision as a removal of “a dose of accommodation” and cited the continued strength of the U.S. economy, ongoing geopolitical uncertainty, and the lack of timely progress in bringing inflation down to the 2% target as the justification for the move. Specifically, as it relates to inflation, Warsh noted the number of categories for which prices are increasing in excess of 3%; this emphasis on diffusion within the underlying data potentially points to the need for a more nuanced assessment of the diverse drivers of inflation and speaks to the challenge of relying on single data points to determine the future Fed path.
As it relates to the state of the economy, Warsh reflected that this week’s meetings were replete with optimism and that recent data is pointing to an acceleration in economic activity. He noted that U.S. labor markets remain strong, with job openings and weekly hours higher, while jobless claims are consistent in his view with a full employment scenario. He also believes that while the Fed is admittedly becoming more restrictive, the dual mandates of price stability and full employment do not need to operate at “cross purposes” over the medium-term. Finally, when asked to opine on the recent move higher in the 10-Year Treasury yield, Warsh pointed to economic strength, the competition for capital given a surge in corporate issuance, and geopolitics – not fiscal concerns, surprisingly, especially given U.S. Treasury Secretary Scott Bessent’s recent comments around the rise in the long end of the curve.
Stocks were modestly lower, and short yields higher, following the press conference. While the equity markets were anticipating the decision, Warsh’s emphasis on working to achieve price stability in a “timelier fashion” was unsettling for equity investors, who had likely anticipated that Warsh would strike a more balanced tone. In addition, the updated projections create a greater level of uncertainty for 2027 – especially given the one-two punch of higher growth coupled with a steady unemployment rate.
The primary takeaway from today’s meeting is that the Fed is “serious” about returning to its 2% inflation target and delivering price stability to the U.S. economy. The challenge is how effective interest rate policy can be in alleviating the likely sources of stickier inflation as we move into 2027 – namely, higher energy prices (and the eventual passthrough of those prices) and AI induced supply-demand mismatches. Higher borrowing costs for U.S. consumers will likely be difficult to digest and could further depress activity in housing and dampen discretionary spending. While one rate hike is not likely to translate into meaningfully lower economic activity, should the economy continue to strength and further drive pricing pressures, this may mark the beginning of a longer hiking cycle.
As such, we have adjusted our view following the announcement and press conference; our base case is that the Fed will hike rates in December and then hold at 4.0% to 4.25% thereafter. We believe pricing for broader categories such as shelter will continue to trend lower, acting as an important offset to the supply side challenges summarized above, but acknowledge a modestly higher risk represented by elevated energy prices. We recognize the continued strength of the global economy, however, and remain constructive on global equities. We anticipate that volatility could remain elevated as we approach the midterm elections, and we would take advantage of that volatility to position ahead of what is likely to be another strong earnings quarter for global companies.
