Will there be a "dovish rate hike" tonight?

Wall Street is holding its breath for the Federal Reserve's interest rate decision on Wednesday. Citigroup and Goldman Sachs are unusually aligned on their core assessment: a rate hike is almost a certainty, but it will be a "dovish rate hike"—the hike itself is not the key point; the key point is what the Fed says after the hike, or, or, doesn't say anything at all.

According to TrendFocus, a recent research report from Citigroup on September 15th indicated that benchmark forecasts suggest the Federal Reserve will define this rate hike as a "calibration," implying no inevitability of further rate increases . Goldman Sachs, in a research report on September 13th, stated that tonight's rate hike will be a "no-signal" one , explicitly stating that it does not believe there is a sufficient economic basis for this rate hike, attributing the excess inflation above the 2% target entirely to one-off factors, and that the economy is not overheated.

Both Citigroup and Goldman Sachs predict that the median dot plot will show only one additional rate hike in 2026, with rate cuts resuming in 2027. Core PCE forecasts are expected to be revised downwards from June data due to methodological revisions, providing data support for a halt to rate hikes.

Despite the dovish baseline scenario, Warsh's press conference will be the biggest suspense for the market. Citigroup believes that if Fed Chairman Warsh refuses to provide clear forward guidance and only emphasizes that "there is still work to be done," the market may repric the expectation of consecutive rate hikes in October and December, triggering sharp asset price volatility. Goldman Sachs believes that Warsh needs to emphasize at the press conference that the committee will "carefully assess" the upcoming data, implying that more information is needed, thereby guiding the market to abandon its overconfidence in an October rate hike.

Analysts believe the key tonight is not "whether to add or not," but "what to say after adding." Every word Walsh utters will be scrutinized by the market.

Dovish baseline scenario: Passive rate hikes and "fine-tuning" set the tone

Current market pricing has forced the Federal Reserve to make a choice. Goldman Sachs believes that after the release of the August CPI data, the market has priced in a near 90% probability of an interest rate hike. To avoid a sharp market reaction caused by remaining on hold, the Federal Reserve will be forced to raise interest rates by 25 basis points at this meeting.

But this will be a thoroughly dovish move. Citi’s baseline forecast indicates that the forward guidance accompanying the rate hike will no longer point to further increases in policy rates.

Federal Reserve Chairman Warsh will most likely downplay the rise in policy rates as a "slight adjustment" or "calibration," and suggest to the market that if inflation shows signs of falling back toward the target, further rate hikes may not be necessary.

Goldman Sachs also expects the Federal Reserve to make only the minimum necessary changes in its statement, avoiding providing forward guidance on the future path, thus presenting a "no-signal rate hike" .

It is worth noting that Goldman Sachs expects Federal Reserve Governor Waller to vote against the proposal. This is because the annualized rate of core PCE inflation (including the anticipated impact of methodological revisions) has fallen to approximately 2.5% over the past three months, below Waller's previously stated "unchanged" threshold of 2.8%.

Goldman Sachs: Does not believe there is a sufficient economic basis for this rate hike.

Unlike Citigroup's strategic analysis perspective, Goldman Sachs' economic research team, starting from fundamentals, explicitly stated that they do not believe there are sufficient economic reasons for this increase in the federal funds rate.

Goldman Sachs' core argument is that all the excess inflation above the 2% target can be attributed to one-off factors whose effects will fade, including tariff effects, the impact of the energy/Iran conflict, software and component price effects, and portfolio management effects. Goldman Sachs believes that the improvement in core PCE inflation to an annualized rate of approximately 2.5% between June and August (including revisions to its expected methodology) is an early sign that the effects of these one-off shocks are fading.

Goldman Sachs also disagrees on the breadth of inflation. Although more categories of goods have recently seen prices rise at an annualized rate of over 3%, Goldman Sachs points out that once the effects of tariffs are removed, the breadth of inflation is roughly equivalent to the level during historical periods of 2% inflation—and the tariff shock has most likely already been priced in.

Furthermore, Goldman Sachs' Bottlenecks Tracker shows that industry-level capacity constraints are now even slightly less than before the pandemic, and are mainly concentrated in a few sectors closely related to the AI boom. The economy is not overheated—and an overheated economy is precisely the core reason for interest rate hikes under normal circumstances.

Macroeconomic evidence also suggests that limited interest rate hikes are unlikely to effectively offset the greater inflationary effects of supply shocks. This means that regardless of whether the Federal Reserve raises interest rates, its main policy logic remains to wait for the effects of past shocks to dissipate naturally over time.

For this reason, Goldman Sachs believes that some FOMC members are highly consistent with their inflation assessment, and the FOMC as a whole is unwilling to send any further interest rate hike signals at this meeting.

SEP Economic Forecast: Dot plot and downward revision of core PCE provide dovish support.

Several components of the Summary of Economic Forecasts (SEP) will collectively reinforce this dovish impression.

Citigroup points out that the median dot plot will show only one additional rate hike this year, with rate cuts resuming in 2027. This path aligns with the Fed's current internal logic: a policy rate of around 4% is already "slightly restrictive," and this restriction should be gradually lifted as inflation returns to its target.

Goldman Sachs' assessment of the dot plot distribution was equally specific and precise: it predicts a narrow majority of 10 to 8 indicating only one rate hike in 2026 (with Waller and other possible members voting for zero rate hikes). Goldman Sachs' reasoning for this assessment is that some members hold ambivalent views on the current rate hike, while others do not want to further increase market expectations for additional rate hikes.

However, Goldman Sachs also clearly pointed out the tail risks: if more committee members view this week's rate hike as a normal response to rising oil prices and AI demand, and as the beginning of a series of rate hikes, then the risk of a majority vote supporting two rate hikes cannot be ignored.

Regarding inflation forecasts, both institutions expect core PCE inflation forecasts to be revised downwards due to methodological revisions. Goldman Sachs anticipates that the median core PCE inflation forecast for 2026 will be slightly lowered to 3.2% from 3.3% in June in the September SEP report, providing data support for halting interest rate hikes.

Walsh's press conference: The biggest suspense in the market

Despite a dovish baseline scenario, Citi warns that the most important and unpredictable variable determining the overall tone is how Chairman Warsh will discuss the rate hike. Warsh's personal style tends to provide less forward guidance, leaving the market with ample room to price in a more hawkish policy.

Citigroup believes that if Warsh merely emphasizes "more work to do" without providing near-term interest rate guidance, it could be seen as a danger signal by the market. In this hawkish risk scenario, the market might expect rate hikes at both the October and December FOMC meetings, and even extend the risk of further rate hikes into 2027.

Goldman Sachs' assessment of this scenario is more specific: The FOMC may want to guide the market to lower its pricing confidence in an October rate hike (currently close to 50%), but will not explicitly state this in its statement. Instead, Warsh may indicate at the press conference that the FOMC will "carefully assess" upcoming data before deciding on further action, or hopes to see multiple upcoming inflation reports, or observe how underlying inflation trends evolve—any of these statements would suggest that the committee wants to collect data for an extended period before taking action.

Goldman Sachs added that, given that many investors view the midterm elections in early November as a political obstacle to an October rate hike, it would not be difficult to prevent the market from setting an October rate hike as the "default baseline."

Goldman Sachs set up three scenarios:

Baseline Scenario (50% probability): Only one rate hike (this time), followed by two rate cuts in September and December 2027, with a final interest rate of 3.25%-3.5%;Multiple rate hike scenario (35% probability): Two to three rate hikes in the end, resulting in higher terminal interest rates;Recession scenario (15% probability): Economic downturn, monetary policy shift.

Even after fully considering the tail risks of multiple rate hikes, Goldman Sachs' probability-weighted federal funds rate forecast is still far more dovish than current market pricing. Goldman Sachs also raised its terminal interest rate forecast from 3%-3.25% to 3.25%-3.5% and postponed the first rate cut in 2027 from June to September.

Citigroup specifically pointed out that the recent sharp fluctuations in WTI crude oil and average U.S. gasoline prices have added additional complexity to the inflation outlook and the Federal Reserve's policy path. If energy prices remain persistently high, it could shake the Fed's assessment that "inflation is on track," thereby reinforcing the stance of hawkish members.

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