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The FOMC unanimously raised the fed funds rate by 25 bps to 3.75-4.00%, underscoring its commitment to policy credibility. We expect only one additional 25bp increase, most likely in December. We then expect the Fed to remain on hold through 2027.

While far from a done deal, Warsh’s Fed has effectively cornered itself into a hike with its hawkish rhetoric. We now lean toward a 25bp rate hike aimed at preserving policy credibility, though a hold remains a distinct possibility.

Today’s 9-3 voting split at the Fed suggests that support for monetary policy tightening has continued to grow within the Committee. The next policy decision will largely depend on whether upcoming inflation data validate the recent improvement in inflation.

The Fed is set to keep the fed funds rate target range unchanged at 3.50-3.75% this week. Chair Warsh will likely reinforce the FOMC’s hawkish lean by pointing to the AI investment boom as a potential source of demand-driven inflation.

While policy rate expectations have risen, lower inflation expectations and term premia cap long-term yields. Warsh’s focus on price stability alongside a massive hawkish shift in the dot plot put concerns over the Fed’s independence to rest, unwinding the debasement trade.

The hurdle for additional easing is now considerably higher than it was earlier this year, while the possibility of future rate hikes can no longer be dismissed if inflation fails to resume its path toward target.

After moderating in April, expectations for Fed rate hikes, as implied by the 2-year Treasury yield, strengthened again in May, driven by uncertainty surrounding the prolonged conflict in the Middle East, resilient economic activity, and the Fed’s hawkish tone adopted in its latest policy decision.