Federal Reserve raises interest rates for the first time in three years! Waller sends a hawkish signal, another 25 basis point hike possible this year

According to Zhitong Finance APP, the Federal Reserve raised its benchmark interest rate by 25 basis points on Wednesday, bringing it to a range of 3.75%-4.00%, marking the first rate hike since July 2023. The new Federal Reserve Chair, Waller, emphasized after the meeting that recent inflation data has not shown substantial improvement in underlying price pressures. The latest "dot plot" has also moved significantly in a hawkish direction, with most officials expecting at least one more rate hike this year.

This rate hike was unanimously approved by the Federal Open Market Committee (FOMC). In its policy statement, the Fed said that U.S. economic activity continues to expand at a robust pace, domestic spending remains resilient, productivity growth is strong, capital investment is solid, employment growth is roughly in line with labor force growth, and the unemployment rate has barely changed; meanwhile, inflation remains elevated, and this policy move is expected to help bring inflation back to the 2% target more promptly.

At the press conference, Waller stated that the Fed has "withdrawn some of the accommodative policy" with the aim of aligning financial and credit conditions more closely with achieving its ultimate policy goals. He specifically stressed that the prices of too many categories of goods and services are still rising at an annualized rate exceeding 3%, and that this summer's inflation data did not convince him that there has been a meaningful improvement in the underlying inflation trend.

A recent series of inflation data has reinforced the Fed's rationale for resuming policy tightening. Core inflation in August rose more than expected, sparking market concerns that price pressures may be spreading from factors such as tariffs and energy price shocks to broader sectors. The Fed's latest projections show the median PCE inflation rate at 3.7% in 2026, and the core PCE inflation rate at 3.4%; more noteworthy, officials now expect overall PCE inflation not to return to 2% until 2029, further delaying previous projections.

"Dot Plot" Turns More Hawkish, Another 25 Basis Point Hike Possible This Year

Compared to the rate hike itself, the market is more focused on the Fed's subsequent policy signals.

The latest economic projections indicate that Fed officials' median expectation for the federal funds rate at the end of 2026 has been raised from 3.8% in June to 4.1%. According to the dot plot, among the 18 officials who submitted rate forecasts, 16 expect year-end rates to be higher than the current post-hike level; 12 project the year-end midpoint rate to be 4.125%, corresponding to a target range of 4.00%-4.25%; the remaining 4 predict rates will go even higher.

This means that after this week's 25 basis point hike, there is clear growing support within the Fed for at least one more rate hike this year. By contrast, in June, only 6 officials anticipated at least two rate hikes for all of 2026. Just like in June, Waller did not submit his own rate projection.

For 2027, the median rate forecast is 4.1%, meaning the Fed may keep rates unchanged next year from the median perspective. However, there is still significant divergence among officials, with some policymakers believing further tightening may still be necessary.

Noah Buffam, Capital Markets Strategist at Canadian Imperial Bank of Commerce, stated that the latest dot plot is clearly hawkish, and that Fed officials expect the return of rates to neutral levels to be slower than previously anticipated by the market, which is also an important reason for the dollar's support.

Dollar and US Treasury Yields Rise, Risk Assets Under Pressure

The hawkish policy signals quickly reverberated through financial markets. After the Fed's decision was announced, the 2-year US Treasury yield, which is most sensitive to monetary policy, quickly rose to 4.71%, up more than 10 basis points from before the decision; the 10-year yield hovered around 5%. The dollar simultaneously strengthened, with the Bloomberg Dollar Spot Index jumping as much as 0.5%, reaching its highest level since August 14.

The foreign exchange market also saw a clear reaction. GBP/USD fell as much as 0.7%, becoming one of the weaker G10 currencies; JPY/USD fell as much as 0.5% to 155.94. Valentin Marinov, Head of G10 FX Research & Strategy at Crédit Agricole, said Waller's remarks were also hawkish, further boosting the dollar.

US equities extended their losses during Waller's press conference. According to data, the Dow Jones Industrial Average closed down by about 1.2% on Wednesday, the S&P 500 index fell about 0.45%, and the Nasdaq index closed nearly flat after erasing earlier losses; the 2-year Treasury yield ultimately rose to around 4.73%, while the 10-year yield reached about 5%.

The market had actually long anticipated this rate hike. Before the decision was announced, as the August inflation data failed to show a clear easing of price pressures, traders were pricing in more than a 90% probability that the Fed would raise rates by 25 basis points. However, as the dot plot suggests further hikes are possible this year, investors are reconsidering the risk that US rates may remain higher for longer.

"Bond King" Gundlach: Fed Should Have Raised by 50 Basis Points

Notably, some well-known Wall Street investors believe the Fed's 25 basis point rate hike was not strong enough.

DoubleLine founder Jeffrey Gundlach, known as the "new Bond King," said that the Fed should have raised rates by 50 basis points in one go on Wednesday, and then decided on next steps based on subsequent economic data. He believes a larger hike would have allowed the federal funds rate to catch up more quickly with the rate levels reflected by the bond market.

Gundlach pointed out that the 2-year US Treasury yield had previously been more than 100 basis points higher than the federal funds rate. Since the 2-year yield typically strongly signals market expectations for short-term policy rates, he thinks the bond market has essentially already sent the Fed a signal that further tightening is needed.

Gundlach also said he worries that both the market and policymakers may still be underestimating the inflation problem facing the US. He was not surprised that US stocks extended losses during Waller's press conference.

Inflation Remains Policy Core, Fed Tightening Cycle May Not Be Over

This decision also marks Waller's first major policy shift since taking over as Fed chair at the end of May. Despite President Trump's ongoing calls to cut rates and his public statements that US borrowing costs should be among the lowest globally, the Fed still unanimously decided to raise rates this time. When asked by reporters what message he wanted to send to Trump, Waller did not further comment on discussions between the two.

Based on signals released by the Fed itself, the current policy focus remains clearly on controlling inflation. The official statement stressed that inflation remains elevated, while economic activity is robust, capital investment is strong, and the job market has not shown significant deterioration, meaning the Fed still has room to suppress price pressures through higher rates.

More importantly, contrary to earlier market hopes that Waller would push for rate cuts after taking office, the latest dot plot shows the Fed's policy path is shifting towards "higher for longer": the end-2026 median federal funds rate forecast has been raised to 4.1%, and most officials support at least one more rate hike this year; meanwhile, the timing for inflation returning to the 2% target has been pushed out to 2029.

This means the 25 basis point rate hike this week may not be a one-off policy adjustment. Upcoming inflation, employment, and energy price data will be key factors in determining whether the Fed will further tighten policy later this year.