Federal Reserve Chair Kevin Warsh announced a 0.25% interest rate hike at the September 2026 FOMC meeting, marking a shift from talk to action in the fight against inflation. Warsh has spent the prior two Fed meetings saying the Fed was committed to price stability, but had refrained from actually hiking rates. However, recent economic indicators—including a strong August jobs report, stubbornly high inflation data, rising oil prices, and climbing long-term interest rates—likely accelerated this decision. Here I’ll discuss the factors driving the Fed’s recent rate hike, potential future rate paths, and what this means for both the stock and bond markets.
Why did the Fed hike rates in September?
The Fed hiked rates in September to combat inflation, which has been above the Fed’s target for the last five years and is showing no immediate signs of abating.
This is more or less what Kevin Warsh said during his press conference after the Fed meeting. However, while this statement is true in a certain sense, it doesn’t answer a bigger question: why now? In each of the prior two meetings, Warsh was willing to merely talk about fighting inflation, saying things like “we will deliver price stability.” So why was September suddenly the time to act?
I would argue Warsh had to hike now or risk real damage to the Fed’s credibility. Several events have occurred since the Fed’s last meeting on July 29th that made a rate hike at the September meeting a necessity.
- Strong jobs report for August: The August employment report showed a big rebound in job growth, with revisions erasing what had originally been reported as a negative report for July. Warsh said during his press conference that the labor market has “strengthened.”
- Inflation data remains too high: Neither Personal Consumption Expenditures (PCE) nor the Consumer Price Index (CPI) reports showed any signs that inflation has slowed the last two months. Warsh said that the data on inflation since the last Fed meeting has not “meaningfully improved.”
- Oil prices keep rising: When the Fed last met at the end of July, crude oil prices were just below $80 per barrel. Today a barrel of oil costs over $100. This diminishes any hope of a quick fix on inflation. Warsh was a little cagier when talking about the Iran War, likely wanting to avoid getting tangled up in politics. But he did say there was “no hiding” from geopolitics, and said the Fed had revised their views of what was “most likely” in regards to the geopolitical situation.
- Long-term interest rates have been rising: There are a few reasons why Treasury bond yields have been rising, including the deficit. However, one major reason is investors pricing in higher inflation for longer. This is in part because the Fed had yet to take action on inflation.
The last point is perhaps the most important. The longer Warsh waited to take action, the more the market was going to question his resolve to actually fight inflation. This was already starting to happen after Warsh’s July press conference. The risks to his credibility would only increase if he failed to act at this meeting.
This is a problem partially of Warsh’s own creation. In the past, the Fed would provide forward guidance, a practice where the Fed would hint at future actions. Warsh has been adamant about eliminating forward guidance. I think there could be some real benefits to the market relying less on Fed speak. However, it means the Fed’s actions have to carry all of the load. One of the benefits of forward guidance was the Fed could hike rates and promise more hikes in the future. This had some of the effects of several hikes, while not completely boxing the Fed into future actions.
In other words, if you knew the Fed were definitely planning on hiking, it becomes less important if they actually hike at any given meeting. If Warsh is going to eschew forward guidance completely, he won’t have this luxury. The Fed will have to show its intentions through action.
Will the Fed continue hiking rates in 2026?
It is likely the Fed will hike one more time in 2026, in our view. Whether they continue to hike into 2027 is very much up in the air.
The Fed released the Summary of Economic Projections after this meeting, which includes the so-called dot plot. This is an exercise where each member of the Fed’s Committee estimates where they would set the Fed’s target interest rate if their own economic forecast comes to fruition. They make this estimation for the current year as well as the next couple years and the “longer-term.” Generally speaking, investment pros focus heavily on the current year when reading the dot plot, with maybe a little attention paid to next year.
For 2026, a strong majority of Fed officials think another hike will be appropriate. Of the 18 Fed officials who gave an estimation (Fed Chair Kevin Warsh doesn’t participate in this exercise), 16 penciled in at least one more hike for this year. This was not surprising. Fed funds futures contracts also had a second rate hike priced in ahead of this meeting.
The dot plot for 2027 is harder to interpret. Six Fed officials think rate cuts will be appropriate in 2027, with one dot suggesting as many as four cuts. Meanwhile eight committee members think the Fed will be hiking at least one more time in 2027. This is certainly an unusually wide dispersion of opinions.
Sometimes the media depicts these kinds of divides as there being opposing “sides” within the Fed committee. That’s not the right way to think about it. The dispersion in the dots almost certainly reflects different economic forecasts. We can see this on display elsewhere in the Summary of Economic Projections. Fed officials also give their forecast for things like inflation and unemployment.
Looking at that section, we see that some Fed officials are projecting that inflation subsides from 3.3% currently to around 2.0% by the end of 2027. This could happen if the economy slows materially, or perhaps oil prices stabilizing helps inflation normalize. If inflation were indeed to fall that quickly, it is likely that rate cuts would be sensible. Others are forecasting inflation to slow only modestly, ending the year at 2.6%. This implies that the economy accelerates and/or that inflation turns out to be more engrained. In that scenario, we would expect the Fed to hike multiple times next year.
This is informing how we’re thinking about interest rate risks in the coming quarters. There is a wide range of possibilities, and the economic outlook is uncertain. This could be the start of an elongated rate hiking cycle or rates could be falling substantially in 2027. We are trying to build portfolios with both possibilities in mind.
What did Kevin Warsh signal about future rate hikes in his press conference?
Warsh said this rate hike was removing “a dose of accommodation.” That phrase may mean more rate hikes are coming.
Warsh used this phrase in response to a question during his press conference. When a Fed official calls rates “accommodative” it means that rates are low enough they are stimulating the economy. Typically “removing accommodation” implies rates are going from low to not-so-low. Normally if the Fed is trying to wring inflation out of the system, the Fed Chair would want rates to be “restrictive” - meaning rates are high enough to be restraining economic activity, and thus hopefully bringing down inflation.
Traders really keyed on this phrase, with the stock market dropping materially after Warsh said it. If we take the phrase literally, it would suggest several more hikes are possible.
I’m not totally sure we should take it literally. Warsh said this in response to a question, not in his prepared remarks. Moreover, Warsh goes way out of his way to not give any forecast about the Fed’s future actions. It seems odd that he’d drop such a big hint in such a manner. He may have simply misspoke.
I don’t think trying to parse Warsh’s every word is going to help make more accurate guesses as to the Fed’s next move. As I said above, I prefer to prepare for a variety of possibilities. The Fed may wind up hiking several more times, but I don’t believe that is a foregone conclusion, regardless of what words Warsh chooses to describe current policy.
How is AI impacting inflation?
Construction costs and energy usage from AI data centers is probably causing some short-term inflation pressure, but Warsh believes AI will be deflationary in the intermediate-term.
During the nomination process for Fed Chair, Kevin Warsh argued that AI would create a productivity boom, which in turn should create long-term disinflationary effects. The idea is that AI would allow production of some goods and services at a cheaper cost, which would tend to drive down prices. There are plenty of precedents for this, including the internet boom of the 1990’s. The subsequent boost in productivity is probably an important reason why inflation was so low during the early 2000’s period.
At the time Warsh said that anticipated disinflation from AI was one reason why the Fed didn’t need to hike rates. Inflation might slow on its own due to this productivity effect.
However, since taking over as Fed Chair, Warsh has been more circumspect. In this press conference, Warsh mentioned the huge influx of capital spending on AI as one reason why the economy has gained strength. He also said one reason why longer-term interest rates were rising was debt financing of this spending, calling it “competition for capital.”
After taking over at the Fed, Warsh appointed five task forces to study some major themes and potentially shape the Fed’s future actions. One of those task forces was on “productivity and jobs in an era of transformation” - essentially an AI task force. It is likely this task force will propose some ways in which the Fed can navigate the short-term and long-term effects of AI.
For now, there are more questions than answers. For example, how much is the surging cost of narrow goods like memory chips really bleeding into general inflation? That isn’t easy to measure. But we think it is fair to say that AI is creating some amount of short-term inflation pressure.
How will Fed rate hikes impact the stock market? Or the bond market?
Both stocks and bonds can perform well despite Fed rate hikes as long as inflation gets back under control.
As I said above, stocks fell after the Fed announcement, especially after Warsh hinted more rate hikes may be coming. Despite this, I think it will ultimately be better for stocks that the Fed starts hiking now. All else being equal, it is true that stocks would prefer the Fed keep rates low. However, that is only the case if inflation stays contained. The longer inflation stays high, the greater the risk that the Fed will be forced into an elongated rate hiking cycle, similar to 2022. Stock investors would much prefer a small number of hikes now that eliminates the risk of a much more aggressive set of hikes down the road.
The story is very similar for bonds. As I wrote above, one reason why longer-term interest rates have been rising is the market fearing that inflation could stay higher for longer. If Warsh can get inflation back under control, longer-term bond yields will likely ease. Avoiding rate hikes won’t keep longer-term rates low in the face of high inflation. It is better for everyone if the Fed restores market confidence that inflation will remain contained in the longer-term.
There is a risk that inflation is more engrained than is currently assumed by the market. I.e., that it will take more than 2-3 hikes to bring inflation under control. In other words, it is possible the Fed has already waited too long, and there will be several more rate hikes in the coming months. I don’t think this is the most likely scenario, but it is one we’re considering when analyzing portfolios.
We think in that scenario, the kinds of stocks most at risk include lower profitability tech stocks, highly indebted companies, and smaller companies. These are all areas where we are currently underweight. This is an example of how we build defense into our portfolios, while not betting on any single scenario. I think it is most likely that 2-3 rate hikes plus some stability in oil prices (even if they don’t fall materially) will be enough to calm inflation fears. But if that turns out to not be correct, we are still confident in our allocation.
