The probability of an interest rate hike has risen to 92%, but the biggest risk is a dovish stance from Warsh: Analysts warn of a sell-off in long-term US Treasuries.

The probability of an interest rate hike has risen to 92%, but the biggest risk is a dovish stance from Warsh: Analysts warn of a sell-off in long-term US Treasuries.

The Federal Reserve is expected to announce its first interest rate hike since 2023 on Wednesday, raising the benchmark rate by 25 basis points to a range of 3.75%-4.00%. Market pricing indicates a probability of over 92% for this rate hike, but analysts warn that what truly determines the market's direction may not be the rate hike itself, but rather Fed Chairman Warsh's remarks at the press conference.

With inflation currently above the 2% target for five consecutive years, and the 10-year Treasury yield climbing above 5% on Tuesday, reaching a 19-year high, doubts surround Warsh's willingness to withstand pressure from Trump to cut rates and demonstrate an anti-inflationary stance. This makes the wording of this meeting far more risky than the interest rate decision itself.

Robin Brooks, a senior fellow at Brookings Institution, wrote in Substack that the market has already priced in four Fed rate hikes by June next year. "If Warsh's remarks are more dovish than the market expects, the result will be a sell-off of long-term Treasury bonds, which runs counter to the goal of this rate hike to anchor long-term yields."

Interest rate hikes are almost a certainty, and the inflation stalemate remains unbroken.

The logic supporting this rate hike is already quite strong. The personal consumption expenditures (PCE) price index, which the Federal Reserve uses to measure its 2% inflation target, has been rising steadily since last year, with an annualized growth rate of 3.7% in both June and July of this year. The latest data to be released on September 30 is expected to show little improvement.

At the monetary policy meeting held on July 28-29, three officials voted in favor of raising interest rates, and several other officials said they were ready to support a rate hike if inflation did not show signs of declining in the near future.

International oil prices have returned above $100 a barrel, Trump announced new tariffs on Canada and threatened to expand the scope of import tariffs, and the continued economic expansion driven by AI spending has further strengthened the reasons for officials to take action.

In his speech at the Jackson Hole Economic Symposium in Wyoming last month, Warsh signaled that policymakers need to be confident that "underlying inflation is returning to the target at a clear and sufficiently fast pace," noting that recent data "has failed to indicate a substantial improvement in the underlying trend."

Pressure is mounting in global bond markets, forcing the Federal Reserve to take action.

The interconnectedness of global bond markets is another force driving the Federal Reserve to raise interest rates. The yield on 10-year U.S. Treasury bonds broke through 5% this week, reaching its highest level in nearly 19 years.

Many economists and investors believe that the overall rise in global borrowing costs has shown a long-term structural trend independent of inflation, which means that if short-term interest rates do not follow suit, monetary policy will actually tend to be looser.

Currently, many Federal Reserve officials, including Warsh, believe that the current policy stance has limited restraining effect on the economy. From this perspective, this interest rate hike is merely a necessary adjustment to maintain the policy stance.

Global bond market dynamics may have also led the Trump administration to tacitly approve this rate hike. If the Federal Reserve breaks with the already highly consensus market expectations and chooses to maintain the current rate, it could trigger investors to question Warsh's credibility in combating inflation, thereby pushing up long-term interest rates.

High mortgage rates remain the biggest real challenge to Trump’s promise to “make life more affordable,” and with the November midterm elections approaching, the political cost of this promise should not be underestimated.

Wording is more crucial than the decision itself; the biggest hidden danger lies in the risk of being a dovish stance.

Robert Sockin, chief U.S. economist at PGIM, said that if the rate hike is passed unanimously, and the quarterly economic projections (dot plot) indicate at least one more rate hike this year, with a possible further action in 2027, it will send a strong signal to the market. He expects the Federal Reserve to raise rates a total of three times this year.

"The real tricky part is that if Warsh's rhetoric is dovish, characterizing this rate hike as a minor adjustment, the market reaction will be very poor," Sockin said, adding that this is expected to be a continuation of Jackson Hole's remarks—"If inflation doesn't fall back quickly enough, we have more work to do."

It is worth noting that Warsh himself had reservations about the dot plot, did not submit his own interest rate path forecast in the forecasts released in June, and warned officials not to fall into the "hall of mirrors trap"—that is, the policy stance is instead hijacked by market expectations that are already following the Fed's signals.

In a research report, Standard Chartered analysts John Davies and Steve Englander argued that with limited new data recently, the market's rising expectations for an interest rate hike are more of an "echo effect," advocating that the Federal Reserve should hold off on rates this week, as "the cost of waiting is extremely low."

However, regardless of the outcome of this week's decision, Brooks' assessment highlights the core risk: at the press conference, reporters will repeatedly press Warsh on his views on the future path of interest rate hikes, "and I'm not sure he has any good answers to that."

The biggest risk lies in the fact that if he continues to express a dovish stance even after raising interest rates, long-term US Treasury bonds will face a sell-off, and his initial intention in raising interest rates was precisely to anchor these yields.

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