According to CME FedWatch on the 15th, the probability of a September rate hike priced into the futures market topped 90%. That is nearly triple the roughly 30% seen a month ago, meaning markets view a hike this month as a virtual certainty. Should the Fed unexpectedly hold rates steady, fallout would be inevitable, with financial institutions that bet on a hike facing substantial investment losses.
Expert views are shifting quickly as well. In a Reuters survey of 101 economists, 86 respondents, or 85%, expected the Federal Open Market Committee to raise the benchmark rate by 25 basis points (1 bp = 0.01 percentage point) at its September meeting. That marks a sharp turnaround from a survey just a week earlier, in which 70% projected no change.
Interest is now focused on whether the Fed's move will extend beyond a single hike into a full tightening cycle. The rate futures market currently assigns a combined 78.1% probability to two or three hikes across the three FOMC meetings from September to December. In the Reuters survey, 37 of 70 economists (53%) expected at least one additional hike by the end of March next year. Diane Swonk, chief economist at KPMG, said a 25 bp increase "may not be the last move but the start of tightening."
This trend is expected to weigh heavily on Fed Chair Kevin Warsh, as it runs directly counter to President Donald Trump's persistent demands for rate cuts. Warsh signaled strong vigilance on inflation at last month's Jackson Hole conference. "We must be confident that underlying inflation is moving toward our target at a clear and sufficient pace," he said at the time. "Otherwise, we have work to do." With international oil prices above $100 a barrel and both consumer and producer prices showing upward pressure, the case for a rate hike has grown stronger.
Some also warn that any signal from Warsh of a hold could cause even greater market turmoil. If the Fed, charged with price stability and maximum employment, stands still despite high inflation, confidence in its commitment to curbing inflation could waver. As of 5 p.m. on the 15th, the U.S. 10-year Treasury yield stood at 5.039%, its highest since July 2007, and observers say long-term yields could climb further if the Fed holds. Bank of America noted that "the Fed faces a choice between raising rates or risking a surge in Treasury yields."
Still, the fallout from a rate hike appears unavoidable. Higher borrowing costs could curb corporate investment and household spending, weighing on the real economy. Rising rates also lower the present value of companies' future cash flows, pressuring share prices. In that case, investment plans by artificial intelligence-related companies could be delayed.
The U.S. government's debt burden is the biggest concern. The Congressional Budget Office estimates net interest costs for the federal government at $16.152 trillion over the next decade. That figure, however, assumes a 10-year Treasury yield of 4.4%. The Committee for a Responsible Federal Budget estimates that if rates run 1 percentage point above CBO projections over the next 10 years, national debt could rise $3.5 trillion more than expected.
Others argue the shock to financial markets may be limited, given how long the hike has been postponed. With the U.S. economy proving more resilient than expected, gradual increases reduce monetary policy uncertainty and give companies time to absorb higher funding costs — factors that are not necessarily negative for equities.
Indeed, the Fed raised its benchmark rate 17 times, by a total of 425 bp, from 2004 to 2006 under chairs Alan Greenspan and Ben Bernanke. Yet the S&P 500 gained 12% over that period. Bloomberg noted that "while a rate-hike cycle can threaten a bull market, the key factor determining the size of the decline is recession."
