The raised the policy rate 25bp and signalled they may raise rates a second time before a long hold throughout 2027. Nonetheless, we see more labour slack than the Fed and remain a little more optimistic on the inflation backdrop. If we see a resumption of energy flows from the Persian Gulf, the situation would favour a “one and done” outcome.
Fed Hike to “Support a Timelier Return” of Inflation to Target
The Federal Reserve has hiked rates 25bp to a target range of 3.75–4%, as widely expected. Markets had moved to swiftly price such an outcome in the wake of Chair Kevin Warsh’s hawkish Jackson Hole address, with subsequent hotter-than-anticipated jobs and core inflation data merely making it a formality.
The decision was unanimous and the press release was brief, as it has been after all three decisions under Warsh’s leadership. Economic activity is “solid”, but uncertainty and inflation remain “elevated”. Nonetheless, today’s decisions will “support a timelier return to the Committee’s 2 percent goal”.
Fed Points to One More Hike Followed by a Long Hold
In terms of the guidance, the central projection within the Fed’s summary of has one more rate hike this year, in line with market pricing, with the central range holding at 4.125% through 2027. They then have the mid-point of the Fed’s funds target range at 3.875% for 2028 and 3.625% for end-2029 and 3.25% for the “longer run”. This is a higher profile range than they projected in June, but is below the market pricing of three additional 25bp hikes.
Within the actual dot plot there are only 18 submissions, suggesting Kevin Warsh again declined to offer a view. Only 2 of the 18 FOMC submissions had no further rate hike this year, suggesting strong backing for another move, and similarly, there are only 4 of 18 that expect to see any sort of rate cut next year. There are 8 of 18 expecting the policy rate mid-point to be 4.375% (2 additional hikes) by end-2027. So this is a more hawkish Fed than in June with them revising up inflation and growth and revising lower unemployment projections despite the data trends suggesting it should be the other way round – in our view.
Indeed, our growth, inflation and jobs forecasts suggest little need for further rate hikes, and it may well be that the Fed are striking a hawkish line in order to build more credibility with bond markets as they look to support Treasury efforts to anchor the long end of the curve.
One and Done Remains Our Call
Ordinarily the assumption is that if the Fed hikes, they don’t move just once, and indeed their forecast table does have a further hike pencilled in. However, this time around we think it may end up being a one-off. While August’s jobs number was a healthy 162,000, between January 2025 and July 2026 the monthly average increase was a measly 31k with hiring indicators suggesting a reversion to that far slower growth rate is likely. Furthermore, while the unemployment rate is low at just 4.1%, the worker participation rate has plunged a full percentage point since early 2025. This suggests there is worker disengagement and more slack in the jobs market than looking at the unemployment rate alone indicates. It is hard to argue against that when wage growth is running at just 3%.
That weak wage growth will be helpful in keeping inflation in check and with the inflationary impulse from tariffs largely incorporated – and IEEPA tariff refunds being a cash flow boost – lower cost pressures here help mitigate higher energy and fuel costs. Furthermore, the shelter component, with a 35% weighting in the CPI basket, should continue to moderate given the stagnant property market and cooling private sector rents. The key uncertainty is energy and the lack of progress surrounding oil and gas flows from the Strait of Hormuz, which has meant headline disinflation has stalled. Nonetheless, our geopolitical assessment is that the situation will improve, and oil prices will resume their declines later in the year, which will rapidly improve the inflation backdrop.
Given market and consumer inflation expectations remain in check, we see parallels with the late 1990s – cuts in early 1996 before a pause, then a one-off ’risk management’ hike enacted by Alan Greenspan’s Fed in March 1997 before a long pause through late 1998.
The Fed Calms the Back End, but We’d Not Be Getting Too Comfortable on It Ahead
Ahead, we maintain a bearish stance on long rates despite the calmness post the decision, as a 25bp hike does not materially change the dynamics that have hampered long rates in recent months. Inflation remains high, as does the fiscal deficit, as is wider issuance. And the AI productivity-driven narrative remains in place. The odds see the breaking back above 5% in the days and weeks ahead. If so, the market will begin to settle at above 5%, and ponder the 5.25% to 5.5% range as an area that is perfectly attainable in light of the still quite loud mood music that has been driving long-end yields.
Delivery of the anticipated 25bp hike, by definition, should not have a material effect. The back end initially took the decision very fine, with yields steady in the 4.95% area, although it had shown a mild bias to test lower, as had been the theme through the morning into the decision. What helped here was the price action of previous days that saw the 10yr yield get above 5%, and indeed close above 5%, thus ticking off the need to necessarily have that reaction post this decision. Chair Warsh will be pleased that the breakout of the 10yr yield shows a moderate fall in inflation expectations, which telegraphs a nod of approval from the market to the hike as an inflation containment one. The 10yr real yield is a tad higher as an offset.
Also, the is a tad richer vs SOFR, although not by much. Even though the 30yr yield is still higher than it was before Treasury Secretary Bessent’s buyback announcement, it’s well below the subsequent highs. And it’s clinging on to a 4bp richening versus SOFR compared with the pre-buyback announcement level. At the other end of the curve, the 2yr was a tad spooked by the unanimity shown by the committee on the hike (Chair Warsh voted for the hike too), and the implied priming for another hike from the dot plot. So, the is up 10bp to almost 4.7% post the decision. And the curve is flatter, mostly from the front end, and the 2/10yr Treasury yield curve is back below 30bp. The is flat on the 2/5/10yr fly though, suggesting that if there are more hikes, it should not be many.
Nothing of note on the plumbing, apart from noting ample bank reserves, suggesting a degree of comfort with balance sheet circumstances. Which is fair. We await the outcome of further deliberations in this space by the end of 2026, with the yet-to-come prescribed action to be taken from 2027.
FX: Hawkish Hike Reinforces Dollar Momentum
The Fed’s message of policy discipline is likely to raise the bar for de-basement trades to re-emerge anytime soon. That should limit downside risks for the dollar, leaving it better placed to benefit from supportive external drivers. As long as energy prices remain firm, we see little reason to fade the current USD appreciation trend.
With the door still open to additional tightening, the dollar also retains upside risk around upcoming data releases. Strong prints could bring hike expectations forward to October, where markets currently price 11bp.
broke below 1.150 after the announcement, and there is little in the way of obvious support before the 1.1330-1.1360 area, where the June decline found a floor. That is likely the extent of near-term downside risk. Our forecast remains more optimistic, albeit heavily reliant on an improvement in the Gulf situation and rapid oil decline by year-end. We target 1.150 for end-September and a modest bump to 1.160 by year-end.
***
Disclaimer: This publication has been prepared by ING solely for information purposes irrespective of a particular user’s means, financial situation or investment objectives. The information does not constitute investment recommendation, and nor is it investment, legal or tax advice or an offer or solicitation to purchase or sell any financial instrument. Read more