Tonight, the Federal Reserve's interest rate hike is almost a certainty, and the market is closely watching Waller's statement: will it signal a continuation of rate hikes?

Author: Dong Jing, Wall Street Journal

Tonight, the Federal Reserve's first interest rate hike of 2023 has almost become a foregone conclusion, but what truly stirs the market's nerves is what Waller says after the rate hike—or what he doesn't say.

Currently, the market's pricing probability for a 25 basis point rate hike by the Federal Reserve this week has exceeded 90%, with the target range being raised from 3.5%-3.75% to 3.75%-4.00%. This expectation has formed due to Waller's hawkish statements at the Jackson Hole meeting, followed by the significantly better-than-expected non-farm payroll data for August, and the core CPI month-on-month increase in August exceeding expectations. The rate hike itself is no longer a suspense; the real focus of the market is: how many more rate hikes will be shown in the dot plot this year, and whether Waller can provide a clear policy path signal at the press conference.

Citigroup and Goldman Sachs are highly aligned in their core judgments: this will be a "dovish rate hike," and the Federal Reserve is unlikely to actively signal continuous rate hikes, with the median in the dot plot expected to show only one more rate hike this year. However, Standard Chartered Bank holds a completely opposite stance—the bank believes that the September rate hike itself is a policy mistake, and the correct choice is to wait for the tariff impacts to subside before making further judgments.

Meanwhile, according to strategy analyses from JPMorgan and Goldman Sachs, if the Federal Reserve raises rates as expected but refuses to provide clear forward guidance, the yield curve may steepen and provide moderate support for the stock market; if Waller unexpectedly releases strong hawkish signals for continuous rate hikes, it will trigger a comprehensive surge in interest rate volatility. Conversely, if the Federal Reserve unexpectedly announces to maintain rates, it will not only severely damage its policy credibility but may also trigger a stock market sell-off and lead to a significant rise in long-term U.S. Treasury yields due to inflation concerns.

It is worth noting that this rate hike by the Federal Reserve may also trigger political friction, as Trump recently reiterated that the U.S. should have the lowest borrowing costs in the world, and the rate hike may expose Waller to fresh criticism from the White House.

Rate Hike Logic: Waller "Pushed to the Wall"

Waller's speech at the Jackson Hole meeting at the end of August has effectively placed him in a dilemma. He clearly pointed out that the 12-month PCE inflation rate is 3.7%, with a six-month annualized rate as high as 4.1%, both far exceeding the target, and more than half of the PCE components are still rising at rates above 3%, warning that unless there is clear progress towards the 2% inflation target, the Federal Reserve "still has work to do."

Two weeks later, the core CPI in August rose by 0.3%, higher than the expected 0.2%, further solidifying rate hike expectations. According to the latest Reuters survey, 85% of 101 economists expect the Federal Reserve to raise rates, with the probability of a rate hike priced in by the money market approaching 90%.

Nevertheless, the rate hike is not a certainty. Federal Reserve Governor Waller's remarks before the "quiet" period of the September FOMC meeting were clearly dovish, stating that if the August inflation data shows sustained progress, he would prefer to keep rates unchanged, but he also added that if inflation is hot, he would consider raising rates. Additionally, the Oxford Economics Institute believes that three consecutive sets of moderate inflation data provide a reason to maintain rates, and dovish arguments should not be easily dismissed.

Citigroup and Goldman Sachs: Passive Rate Hike and "Calibration" Tone

An article from Wall Street Journal stated that Goldman Sachs expects the Federal Reserve to raise rates by 25 basis points at the September FOMC meeting, not due to solid economic logic, but more due to being "forced" by market pricing. The Federal Reserve will only make the minimum necessary modifications in its statement, avoiding providing forward guidance on future paths, essentially presenting a "no signal rate hike."

Goldman Sachs clearly stated that it does not believe this increase in the federal funds rate has a solid economic foundation. Goldman Sachs' core argument is that the entire extent of inflation exceeding the 2% target can be attributed to one-time factors that will fade, including tariff effects, energy and Iran conflict impacts, software and parts price effects, etc. Goldman Sachs believes that core PCE inflation improved to an annualized rate of about 2.5% from June to August (including methodological revisions), which is an early sign of these one-time shock effects fading.

On the issue of inflation breadth, Goldman Sachs also holds dissenting views. Although more categories of prices have recently risen at an annualized rate of over 3%, Goldman Sachs pointed out that once tariff effects are excluded, the breadth of inflation is basically comparable to levels during historical periods of 2% inflation. Moreover, Goldman Sachs' "bottleneck tracking indicator" shows that industry-level capacity constraints are now even slightly less than before the pandemic, indicating that the economy is not overheating—whereas economic overheating is typically the core reason for rate hikes.

Goldman Sachs believes that after the release of the August CPI data, the market's pricing probability for a rate hike has approached 90%, and to avoid severe market reactions from inaction, the Federal Reserve will be forced to raise rates—this is a rate hike "forced out" by market pricing, rather than a proactive tightening driven by fundamentals.

Citigroup's baseline forecast indicates that the Federal Reserve will define this rate hike as a "calibration" and suggest that there is no inevitability of further rate hikes in the future. The forward guidance accompanying the rate hike will no longer point to further increases in the policy rate. Waller will likely downplay this rate hike as a "slight adjustment" or "calibration" and hint to the market that if inflation shows signs of falling back to the target, further rate hikes may not be necessary.

Dot Plot: One or Two, the Suspense Remains

In the absence of clear statement guidance, the dot plot and Waller's press conference have become the biggest suspense for the market.

Timiraos from the New Federal Reserve News Agency and The Wall Street Journal pointed out that the Federal Reserve has only completed a "hike and stop" operation once in history, in 1997 , and historical patterns indicate that rate hikes often occur in sequences. Former Federal Reserve Vice Chairman Richard Clarida also stated, "If rates are raised next week, there will definitely be more to follow." Currently, CME FedWatch data shows that the market has priced in nearly four rate hikes cumulatively before October 2027.

Goldman Sachs expects the dot plot to show a narrow majority of 10 votes to 8 for only one rate hike in 2026 (with Waller and possibly other committee members voting for zero rate hikes). Goldman Sachs provides this judgment based on the reasoning that some committee members hold contradictory attitudes toward this rate hike, while others do not wish to further raise market expectations for additional rate hikes.

However, Goldman Sachs also clearly points out the tail risk: if more committee members view this week's rate hike as a normal response to rising oil prices and AI demand, and see it as the beginning of a series of continuous rate hikes, the risk of majority support for two rate hikes cannot be ignored.

Regarding dissenting votes, Goldman Sachs expects Waller to cast a dissenting vote, as the annualized rate of core PCE inflation (including methodological revisions) has fallen to about 2.5% over the past three months, below his previously set "hold steady" threshold of 2.8%.

The economic projections summary (SEP) released simultaneously with the interest rate decision will be another focus for the market. In terms of inflation forecasts, both Citigroup and Goldman Sachs expect the core PCE inflation forecast to be revised downward due to methodological revisions. Goldman Sachs expects the median forecast for core PCE inflation in 2026 to be slightly adjusted down from 3.3% in June to 3.2%, providing data support for stopping rate hikes. The median points for 2027 and 2028 are expected to show one rate cut each, maintaining at 3.625% and 3.375%, respectively.

Goldman Sachs also noted that the estimate of the neutral interest rate may slightly shift upward at this meeting and gradually rise to about 3.25%-3.5% over the next year—partly because the economy continues to perform well at higher interest rates, leading some committee members to believe that current rates are close to neutral levels, and AI investment demand may also push up the equilibrium rate.

Waller's Press Conference: The Market's Biggest Uncertainty

In addition to the dot plot, Waller's press conference will be the biggest source of uncertainty tonight. It is worth noting that Waller is expected to once again refuse to submit personal forecasts, continuing his consistent resistance to forward guidance.

Regarding the press conference, Citigroup warned that if Waller merely emphasizes "more work to do" without providing recent interest rate guidance, this may be seen by the market as a dangerous signal. In this hawkish risk scenario, the market may expect rate hikes at both the October and December FOMC meetings, or even extend the risk pricing for further rate hikes into 2027.

Goldman Sachs' judgment on this scenario is more specific: the FOMC may wish to guide the market to lower its confidence in pricing for an October rate hike (currently close to 50%), but will not explicitly state this in the announcement. Instead, Waller may indicate at the press conference that before deciding on further actions, the FOMC will "carefully assess" the upcoming data, or hope to see multiple forthcoming inflation reports, or observe how potential inflation trends evolve—any of these statements would suggest that the committee wishes to collect data for a while longer before taking action.

Goldman Sachs also added that since many investors have viewed the midterm elections in early November as a political obstacle to an October rate hike, it is not difficult to prevent the market from setting an October rate hike as the "default baseline."

Waller faced market criticism for failing to clearly explain the decision to hold steady at the press conference following the July meeting, which triggered a jump in long-term U.S. Treasury yields. If he is again vague this time, the market reaction may be even more severe.

Standard Chartered: The Rate Hike Itself is a Policy Mistake

A report released by Standard Chartered Bank on September 14 takes a completely opposite stance, clearly judging that the Federal Reserve should maintain rates at this meeting and believes that the current rate hike is still a "wrong policy choice."

The core argument from Standard Chartered is that there is a possibility that current core inflation is overestimated. The super core CPI tracked by the bank has recently shown a significant decline, returning to the normal range of the 2010s. The chained core CPI has recently diverged significantly from core PCE, with the chained CPI better reflecting actual consumer spending, and its recent trend is worth policymakers' attention. Additionally, multiple analyses within the Federal Reserve suggest that tariffs may contribute about 0.7 percentage points to PCE inflation, and as tariff revenues peak in the fourth quarter of 2025, their inflation impact may gradually weaken in the coming months.

Standard Chartered also pointed out that market pricing has formed a reverse constraint on policy, with the risk of a feedback loop where "market expectations drive policy, and policy reinforces market expectations." Waller himself warned in his Jackson Hole speech that if the market relies on Federal Reserve guidance, and the Federal Reserve in turn relies on market prices, policymakers may overlook new economic changes, increasing the risk of policy mistakes.

In terms of voting logic, Standard Chartered believes that three committee members supported a rate hike at the July FOMC meeting, and if a rate hike is to be achieved in September, at least four members who were originally inclined to hold steady would need to shift their stance to reach the seven-vote threshold. Standard Chartered believes that current data is insufficient to meet this condition.

Asset Pricing and Volatility Game: How Will the Market Respond?

The Goldman Sachs interest rate volatility research team pointed out in their report on September 15 that the implied volatility of U.S. interest rates has generally remained restrained during the ongoing rise in yields, but last week's sell-off was accompanied by a significant increase in volatility. After controlling for broader macro fundamental factors, the current implied volatility of U.S. interest rates has risen from the lower end of the fair value range to near the midpoint, indicating that the market is vulnerable to scenarios where the distribution of policy paths further expands.

Goldman Sachs believes that if the Federal Reserve raises rates by 25 basis points as expected, the subsequent direction of volatility will mainly depend on the forward guidance conveyed by the Summary of Economic Projections (SEP) and the press conference. If the dot plot shows one to two rate hikes, accompanied by an emphasis on data dependence, it may not completely eliminate forward uncertainty, but it should lead to a decline in volatility and flatten the curve's tail.

Goldman Sachs' historical research shows that when the market has priced in a 75%-90% probability of a rate hike, a mild hawkish surprise (i.e., a rate hike as expected) often brings better volatility sell-off returns, supporting the judgment that volatility will partially decline under the "rate hike as expected + moderate signals" scenario.

Conversely, if the Federal Reserve unexpectedly holds rates steady, Goldman Sachs believes this will trigger a larger shock across the entire volatility surface— not only will it not immediately lower future rate hike expectations, but it will also exacerbate front-end uncertainty while maintaining inflation concerns and term premiums. Last week's European Central Bank meeting provided a reference: strong hawkish signals accompanied by a rate hike led to a sharp rise in short-end volatility, which spread across the entire curve.

In its baseline scenario, Goldman Sachs expects that if subsequent inflation data is sufficiently mild, the Federal Reserve will pause rate hikes after this week's meeting, and volatility will gently decline as the risks of rate hikes gradually fade.

According to scenario analysis by JPMorgan's strategy team, if the Federal Reserve raises rates without forward guidance (baseline scenario), the S&P 500 index is expected to rise by 25 to 75 basis points; if Waller unexpectedly releases a strong signal to "crush inflation," the stock market could face a decline of 1% to 2%.

The most dangerous tail risk lies in "unexpectedly not raising rates," which would not only trigger a dovish repricing of front-end rates but also cause long-end yields to soar due to inflation concerns and credibility damage, sharply steepening the yield curve and triggering a stock market sell-off.