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Fed raised interest rates after three years. What’s next for the dollar?
Fed raises rates again, but the market does not see a clear start to the full cycle
FOMC raised the federal funds rate range by 25 bp, to 3,75-4,00%. This is the first rate hike by the Fed since July 2023. The decision was unanimous, by a 12 to 0 vote.
For markets, more important than the size of the move itself is the fact that there is no clear majority in the Committee today ready to carry out the full cycle of monetary tightening. That suggests September’s decision may be more of a cautionary signal than the start of a long series of rate hikes.
At the previous meeting, 9 FOMC members wanted to keep rates unchanged, while 3 voted for a hike. Such a quick shift in stance shows that there has been a clear change in views inside the U.S. central bank, although not full agreement on the future path of rates.
The statement says inflation remains elevated and that today’s decision is meant to help bring it back to the 2-percent target more quickly. At the same time, the futures market had already priced in more than a 90% chance of a 25-basis-point hike, so the move itself was not a surprise. The doubts were more about whether the Fed would already opt for a more aggressive policy.
What the new set of forecasts says
As every quarter, Committee members also updated their macroeconomic forecasts. The median expectation for GDP growth was revised slightly higher, from 2,2% to 2,3% this year and from 2,3% to 2,4% in 2027. At the same time, estimates for the unemployment rate over the next 2-3 years were lowered, from 4,3% to 4,1%.
The least changed expectations were for PCE inflation, the personal consumption expenditures index that the Fed uses as one of its main gauges of price pressure. According to the median forecast, inflation is set to average 3,7% this year, fall to 2,3% in 2027 and to 2,1% in 2028. That means most policymakers expect a gradual return of prices toward the target, without the need for much more aggressive rate increases.
The distribution of forecasts shown in the so-called dot plot suggests that one more 25-basis-point hike is still possible by the end of 2026. However, there is no majority for additional hikes in 2027, and for 2028 there is still one rate cut in the projections. In practice, the market may therefore read today’s decision as a hawkish move, but not as the opening of a decisive tightening cycle.
The next FOMC meeting is scheduled for 27-28 October. Before the statement was published, the market put the odds of an October hike at 43%, and for December it was already pricing in about an 80% probability of another move higher. The focus will therefore remain on the next inflation, labor market and economic activity data.
Warsh: inflation is too high
At the press conference, Fed Chair Kevin Warsh stressed that the Committee raised rates to support its dual mandate, meaning price stability and the labor market. He noted that the central bank continues to pursue a policy of keeping abundant reserves in the banking system, and that price stability remains the goal.
Warsh also said that investment looks solid, job growth is in line with the size of the labor force, and the unemployment rate has changed little. At the same time, he admitted that inflation remains elevated. He said plainly that it has been above the 2-percent inflation target for more than 5 years.
The Fed chief added that the inflation target was last met in February 2021. He also stressed that today’s decision was driven by the assessment of the situation, the employment outlook, the strength of the economy, inflation trends and the geopolitical situation. When asked about the market’s influence on the central bank, he replied that he watches market prices, but the decision belongs to the Committee.
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