The Federal Open Market Committee on Wednesday increased its federal funds policy rate by 25 basis points to a range between 3.75% and 4%.
And the FOMC signaled more increases to come. The FOMC’s interest rate forecast, or dot plot, implies that the central bank will lift rates by an additional 25 basis points by the end of the year.
In addition, at least eight members signaled that they would lift the rate by an additional 25 basis points through next year, which would push the policy rate to 4.5%.
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A rate at that level would be 100 basis points above the RSM estimate of the terminal rate of 3.5% and 125 basis points above the Federal Reserve’s estimate. The FOMC’s vote on Wednesday was unanimous.
Just about every economic indicator suggests that the Fed rate increase was appropriate and that it is time to bring inflation back to Fed’s 2% inflation target.
The economy is at full employment with above-trend growth—nominal GDP was 6.6% in the second quarter of the year. The deficit to GDP ratio is at or near 5.8% this year, financial conditions stand at just under one standard deviation above neutral, core PCE inflation is 3.3% and headline inflation has resided above the 2% target for the past five years.
On top of this, the economy is experiencing $1 trillion in privately financed artificial intelligence investment.Based on the policy materials, we think that the Fed is embarking on a rate hiking cycle that will result in at least three 25 basis-point hikes to restore price stability defined as 2% inflation.
If anything, the committee is underestimating the heavy lift that will be necessary to restore price stability under current economic and financial conditions within the context of the three shocks—tariffs, energy and the AI build-out—that the economy has absorbed in a resilient fashion.
Policy statement
While the FOMC’s policy statement noted that uncertainty remains elevated because of geopolitical developments (the war-induced energy shock), it made the case that Wednesday’s policy action would support a timelier return to the central bank’s 2% target.
One internal inconsistency in the Fed policy materials is that the committee pushed back its expectation of returning to the 2% target to 2029, which is longer than previously indicated in the Summary or Economic Projections released in March.
Summary of Economic Projections
The Summary of Economic Projections implied that the economy will grow at a quicker pace and remain at or near full employment, but that inflation will increase in the near term. The Fed has pushed back its estimate of moving back to price stability defined as 2% inflation to 2029.
The SEP saw a modest upward revision to growth to 2.3% this year and 2.4% next year. It provided a first forecast for 2029 growth at 2.1%. Long-run growth continued to be estimated at 2%.
The unemployment rate projection was revised down to 4.1% this year and through 2029. The long-term unemployment rate remained the same, at 4.2%
The projection for the personal consumption expenditures index, the Fed’s preferred measure of inflation, was revised up to 3.7% this year, 2.3% for next year and 2.1% in 2028. The Fed now estimates that PCE inflation will not reach the 2% target until 2029.
The core PCE projection for this year was revised up to 3.4%,. For next year it is projected to be 2.5%, and for 2028 it was revised up to 2.2%. It is expected to reach 2% in 2029.
The federal funds policy rate projection was revised up to 4.1% for this year and next–eight members think that it will be higher next year. In 2028, the committee expects the terminal rate to come down to 3.9% and to 3.6% in 2029. The new Fed terminal rate appears to be 3.25%.
Warsh press conference
Warsh was appropriately hawkish in his press conference and sought to reinforce the Fed’s credibility on restoring price stability while simultaneously bolstering his own.
The Fed chair followed his Jackson Hole comments by reiterating his and the Fed’s commitment to the 2% inflation target.
Warsh twice noted that the beneficiaries of the rate hike are the least well-off inside the American economy and continued to stress his approach of being hawkish without engaging in forward guidance.
Those less well-off households will bear a disproportionate burden of adjustment to a rising federal funds rate that indirectly affects variable-rate credit cards, adjustable-rate mortgages and home equity lines of credit
The takeaway
The Federal Reserve hiked its policy rate to a range between 3.75% and 4% to put the economy on a path back to price stability defined as meeting the central bank 2% inflation target.
In our estimation that will require further rate hikes, and we expect the Fed to hike at least two more times—in December and in March—to put the central bank back on a plausible path to 2% inflation that its own Summary of Economic Projections now says will not occur until 2029.
