September 2026 Fed & Rates Call Update

The start of a hiking cycle, or a chance to bolster credibility? An update on the rates path...

• The hotter August CPI spoils the disinflation momentum that started earlier this summer. Goods inflation appears to have reemerged, with elevated pressure from energy prices, import and shipping prices, and reinstituted tariffs. Inflationary risks in non-housing services are fairly muted, but the rate of disinflation has proven to be slow, likely too slow for much of the FOMC at this point. While the 3-month annualized growth rate for core CPI sits firmly within the Fed’s target, core PCE is running considerably hotter (with noncyclical healthcare services playing a role, due in part to the expiration of ACA subsidies). It remains unclear how much quicker inflation would cool under a modest hiking cycle (1-3 hikes), but in the face of persistent supply shocks, ongoing massive fiscal deficits, and questions surrounding credibility, the Fed may have their hands tied.

• Fed Rate Path: Up until two weeks ago, our spec sheet supportive of the Fed remaining on hold was looking good. However, the very hawkish Jackson Hole Speech by Chair Warsh, followed by a solid NFP and hot CPI, has forced us to re-think our Fed rate path. Given what is priced-in for the upcoming September FOMC, it would be difficult for the broader FOMC to hold rates firm. As a result, we now expect the Fed to hike rates by 25bps in September. We have been on the more dovish side and have underestimated the sequence of events that would bring the Fed into a hiking mode so soon. However, we still think raising rates may end up being a policy error, but at the same time, doing nothing will be problematic given Warsh’s repeated view that “inflation is a choice.”

• On a go-forward basis, we think markets will keep 1-2 more hikes priced-in beyond what likely gets delivered at the September FOMC. Therefore, we think hiking expectations for each subsequent meeting in 2026 will trade in a 30-60% probability range of a 25bp hike. That said, we believe the Fed will skip the October FOMC meeting (assuming they go in September) given its proximity to the midterm election. More importantly, we do not believe the Fed wants to signal they are in a rush to adjust policy at such a fast pace.

• We do not believe that a second hike is a done deal either. We assign a 55-60% probability of the Fed hiking in December and then holding rates steady in the target range of 4-4.25%. A lot can, and likely will change between now and December. The outcome of the war is key, where if things stabilize, energy prices can meaningfully decline and take pressure off consumer goods prices before substantial second round effects from high diesel prices kick in, for example. Any sort of tightening of financial conditions can result in the Fed not hiking again too. Lastly, if current projections for the midterms (a democratic sweep) also occur, markets will then pivot to gridlock fears and start entertaining the real possibility of less government spending and maybe even fiscal consolidation talks. Our view is that the recent drift to higher inflation is not of the Fed’s making, but rather, it’s been years of unchecked fiscal policy and recent moves in energy prices.

• US Rates Forecasts: Given the change to our Fed rates outlook, we shifted most tenors upward by a range of 25-50bps in all quarters through our forecast horizon. We think the market has priced-in a lot of the Fed path already and there is a risk it has overshot. It’s unusual for the Fed to start cutting rates immediately after hiking, so we remove that from our profile, but we expect longer-dated USTs to enter 2027 in a position to see bonds rally (especially if the economy were to soften, inflation tempers and/or fiscal consolidations gets into focus) and eventually for even the front-end to rally if Fed hikes end up being one of the catalyst that helps tighten financial conditions in risk markets.