Is the First Rate Hike of the 'Warsh Era' Coming? Wall Street Has Calculated Three Scenarios

The real focus of the Federal Reserve meeting is not the nearly fully priced-in 25 basis point rate hike, but whether Warsh can regain control of the policy narrative, which is key to shifting the pricing logic of U.S. stocks, bonds, currencies, and gold.

Written by: Wu Yu, Jin Ten Data

At 2:00 AM Beijing time on Thursday, the Federal Reserve's FOMC will announce its interest rate decision and economic projections summary. Half an hour later, Fed Chair Kevin Warsh will hold a monetary policy press conference.

The Fed's rate hike this week seems to be a foregone conclusion, marking Warsh's first rate hike since he took the helm in May this year. In the July meeting, the Fed maintained interest rates with a 9 to 3 vote; however, just over a month later, the market is almost certain that the central bank will re-enter the rate hike path.

This meeting is particularly significant for Warsh, as it may test whether he can redefine a rate hike that has been almost fully "priced in" by the market into a policy action defined by the Fed itself.

As of Tuesday, federal funds futures indicated that traders expect a 92.5% probability of a 25 basis point rate hike, raising the target rate range from the current 3.50% to 3.75% to 3.75% to 4.00%. A recent Reuters survey also showed that most economists expect the Fed to raise rates this week.

However, the problem is that the market has already made the first choice for the Fed, and Warsh must now answer: why must we raise rates now, and what will happen after the hike?

From 'Can Wait' to 'Must Act': The Fed's Policy Logic is Changing

For most of this year, the Fed's internal judgment on inflation has been that there is still room for observation. Tariffs and the energy supply shocks caused by the Iran war have been viewed by many policymakers as temporary factors pushing up prices, so even with inflation above 2%, there has not been enough reason to raise rates immediately.

The statement from Fed Governor Christopher Waller is the most representative. He stated in early September that "we should give inflation some time to cool down," believing that the moderate inflation data from June and July still shows that price pressures may continue to fall back toward the 2% target. He also mentioned that the cost of waiting for one meeting is limited, as a 25 basis point rate hike would not immediately bring CPI back to 2%.

New York Fed President John Williams also believed that "waiting and observing" was a reasonable choice.

But the current environment has changed.

The U.S. core CPI rose 0.3% month-on-month in August, exceeding the pace consistent with the 2% inflation target. Meanwhile, oil prices have surged back above $100 per barrel due to the situation in the Middle East. Warsh himself warned at the Jackson Hole annual meeting at the end of August that if policymakers cannot gain more certainty about inflation moving toward the 2% target, the Fed "still has work to do."

This has led the Fed to face an increasingly difficult question: whether the inflation pressures previously seen as temporary are lasting longer than expected.

Sebnem Kalemli-Ozcan, an economics professor at Brown University, believes that the Fed will have to raise rates sooner or later, and the longer it waits, the more persistent inflation may become, leading to more serious problems.

J.P. Morgan economist Michael Feroli expects the Fed to raise rates this week but believes that the rate decision is actually more uncertain than the market's current pricing of over 90% for a hike.

Scotiabank economist Derek Holt even believes that raising rates now may not be the right choice, but Warsh's previous statements have made it difficult for him not to raise. "If the market has already priced it in so much and you still don't raise, then when will you?"

In other words, Warsh is not simply facing changes in inflation data, but rather a situation where previous policy statements, the latest inflation data, and market pricing have gradually pushed him toward the side of raising rates.

Once Rates are Raised, the Real Question Becomes 'How Many Times'

Thus, this 25 basis point rate hike may just be the beginning.

The 9 to 3 vote in the Fed's July meeting is an important starting point for understanding the current policy divergence. Harker, Logan, and Kashkari had already advocated for a rate hike; while Waller, Williams, and others believed that further observation was necessary.

Meanwhile, Lisa Cook had previously stated that she was "prepared to take action" to address inflation; Michael Barr also expressed concerns that temporary price pressures could further solidify.

This means that the final vote outcome of this meeting will tell the market whether the "three votes for a rate hike" in July was merely a minority opinion or is becoming a broader policy shift.

David Kelly, chief global strategist at J.P. Morgan Asset Management, believes that if a majority of committee members ultimately support a rate hike, some previously hesitant officials may join the majority to present a more unified stance, potentially leaving only two, one, or even no opposing votes.

More importantly than the vote outcome is the new dot plot.

Investors will be watching how many officials believe another rate hike is necessary by the end of this year and how the rate expectations for 2027 change.

David Mericle, chief U.S. economist at Goldman Sachs, previously believed that most of the inflation above 2% comes from one-time factors, and the economic fundamentals are not strong enough to support a rate hike. Therefore, Goldman Sachs initially expected the Fed to hold steady this week but later changed its forecast to bet on a rate hike, one of the main reasons being that market expectations have clearly shifted.

Thus, the interest rate path announced by the Fed this week is likely to be more important than the 25 basis points itself.

If the dot plot only reflects limited further rate hikes, the market may interpret the September action as an adjustment to current inflation risks; if more officials begin to support consecutive tightening, the September rate hike could be defined as the starting point of a new rate hike cycle.

It is the latter scenario that the market has not fully digested.

Warsh's Biggest Challenge: Not Trump, but the 5% U.S. Treasury Yield

Warsh also faces a unique dual pressure. On one side is the White House, and on the other is the bond market.

Trump reiterated last Sunday that the U.S. should have the lowest borrowing costs in the world. Although he has noticeably reduced direct attacks on the Fed, he still implies that Warsh is influenced by other "very politicized" Fed officials.

If Warsh raises rates this week, it will directly conflict with Trump's demand to lower rates, and it is very close to the midterm elections in November. Higher borrowing costs may further increase the housing and consumption burden on American residents and put more pressure on the White House regarding the cost of living.

Additionally, the yield on the U.S. 10-year Treasury bond broke 5% on Monday, with high oil prices, inflation pressures, and market expectations for Fed rate hikes collectively pushing up long-term yields. Analysts at Bank of America even believe that the Fed faces a choice between "raising rates or risking further significant volatility in the bond market."

This creates a very delicate change in Warsh's task: if he does not raise rates, he needs to explain why his previous strong stance on inflation did not translate into policy action; if he raises rates, he must explain why this will not evolve into a longer tightening cycle, further pushing up already pressured long-term yields.

This is why his press conference may be more important than the rate decision itself.

In the post-meeting press conference on July 29, Warsh did not clearly explain the reasons for maintaining rates, nor did he adequately elaborate on his economic judgment, leading to a rise in long-term U.S. Treasury yields and criticism from the market. By the time of Jackson Hole, his speech had clearly leaned more toward inflation risks.

Now, the market will ask the same question again: if the Fed really raises rates again, is Warsh willing to tell the market that this is just one action, or the beginning of a series of actions?

But this precisely touches on Warsh's previously clearest policy style—he does not like to provide forward guidance.

Oscar Munoz, an economist at TD Securities, stated, "If Warsh still wishes not to provide forward guidance, he must be cautious in his wording during his speech... If the Fed decides to tighten policy, he will definitely be asked about future rate hikes. We are quite clear that if the Fed chooses to raise rates in September, further tightening measures will be inevitable. How Warsh balances this will be very interesting to watch."

Under the dual pressure from the bond market and Trump, Warsh needs to strike a balance between two goals: to demonstrate that the Fed is willing to act on inflation while not easily allowing the market to interpret this decision as the beginning of an endless series of rate hikes.

Wall Street Institutions Project Three Scenarios

Because of this precarious "tightrope" dilemma, Wall Street's focus on this meeting has shifted from interest rate levels to asset price reactions.

Michael Rosen, chief investment officer at Angeles Investment Advisors, believes that U.S. stocks can digest one rate hike.

Tom Essaye, founder of Sevens Report Research, also stated that the market can withstand this rate hike and even another one in 2026. If the path ultimately forms as "one to two times, then end," the market may not react violently, as it helps to curb inflation and refutes the claim that "the Fed lacks independence," especially in the context of concerns that it may be pressured by the White House to lower rates.

Essaye mentioned that in recent months, the market has generally believed that the Fed's independence is under threat, which has driven yields in the bond market higher. This month, the stock market has fallen due to soaring bond yields, with the 10-year U.S. Treasury yield rising to about 5% during Tuesday's trading. If the Fed can take small actions to "prove its seriousness about inflation issues," the 10-year Treasury yield may slightly retreat, "falling a few basis points."

In Essaye's view, even if the Fed decides to keep rates unchanged but hints at a possible hike later this year, the stock and bond markets may still face some shocks this week. He pointed out that this could occur after an initial "rebound" driven by trading algorithms, based on the logic that fewer rate hikes are preferable; "but considering concerns about inflation and credibility, I find it hard to believe that these early gains can be sustained."

In this scenario, he expects long-term Treasury yields to rise, putting pressure on the stock market, while "currency devaluation trades" may heat up again. Currency devaluation trades could lead to a weaker dollar and strong performance in commodities priced in dollars, such as gold, and physical assets.

However, if the Fed signals that it will continue to raise rates three times or more in the future, the situation could be completely different. Essaye expects that at that time, the 10-year Treasury yield may significantly break above 5%, and U.S. stocks will face greater pressure (possibly dropping more than 1%), with cyclical stocks, value stocks, and high-growth tech stocks all potentially impacted. The dollar will strengthen significantly against other major currencies.