The FOMC delivered a 25bp increase in September to limit secondary inflation risks from energy prices and strength in domestic investment. Members should follow up with a second 25bp hike in October to give participants confidence inflation will return to target in a timely manner. November’s election is a risk to this timeline, however.
The FOMC voted to raise the fed funds rate by 25bps to a mid-point of 3.875% in September, in line with market expectations. The updated dot plot points to at least one more hike by year end. 8 of the 18 members who submitted forecasts also signalled the risk of an additional hike by end-2027. Arguably this would come early in the year, if necessary.
Justifying the September decision, both the Committee’s revised forecasts and the commentary given by Chair Warsh in the press conference focused attention on the risks to the inflation outlook, while showing strong confidence in underlying economic momentum.
Annual PCE inflation is forecast to slow from 3.7%yr in 2026 to 2.3%yr in 2027, then 2.1%yr in 2028 and 2.0%yr in 2029. Core inflation meanwhile is expected to track down from 3.4%yr in 2026 to 2.5%yr in 2027, then 2.2%yr in 2028 and 2.0%yr in 2029. These forecasts are little changed since June despite today’s rate hike and the additional tightening forecast. Implicit here is that the FOMC is acting against renewed inflation risks and believes policy will prove effective in time.
The fervent belief the Committee has in the underlying health of the US economy is clear in the GDP and unemployment rate projections. Despite tighter policy, members’ GDP forecasts were a touch higher in September than June, at 2.3%yr in 2026, 2.4%yr in 2027, 2.2%yr in 2028 and 2.1%yr in 2029 – all above the FOMC’s current estimate of potential, 2.0%yr.
The unemployment rate is consequently forecast to hold at 4.1% through to the end of 2029, consistent with full employment being maintained. Like the other median projections, the range for the unemployment rate is tight, with the upper end of the range just 0.2ppts higher at 4.3%.
The financial context given for today’s decision is also notable. Asked whether the current stance is restrictive, Chair Warsh stated that, ahead of the decision, both he and the Committee were “hard pressed” to describe financial conditions as restrictive. September’s hike was then characterised as removing a dose of accommodation, implying policy is now, at most, neutral.
In gauging the degree of tightening required from here though, Chair Warsh commented that he did not believe the Committee needed to do “harm” to the labour market to bring inflation down. This suggests a definitively restrictive stance is likely not necessary. Rather, tightening twice by year end (including today’s hike) and continuing to flag a willingness to do more should prevent secondary effects from energy prices and the AI infrastructure buildout, until the inflationary impulse from each factor ebbs. ‘Neutral’ today is therefore likely to be higher than neutral in 2028, 2029 and the longer run, a trend evident in the median expectation for the fed funds which falls to 3.2% beyond 2029.
Westpac is more cautious on the downside risks to the labour market and growth, but only at the margin. We meanwhile believe it will take time for headline annual inflation to slow given geopolitical uncertainty and the limited interest rate sensitivity of domestic US inflation, particularly shelter. Another hike by year end should give market participants confidence that policy will prove effective within the forecast window. The Committee is likely to stand ready to deliver a third hike, but this is less than a 50/50 chance currently. Rate cuts will not be seen until 2028 though, and they are likely to only reverse the current tightening, with limited spare capacity in the US economy outside of tech to bias inflation above 2.0%yr in the medium term.
