Maybe more than once or twice! Federal Reserve hawks resurface Wall Street prepares for more rate hikes

The Zhitong Finance App learned that Wall Street is looking for telltale signs from the Federal Reserve's rhetoric to prepare for more interest rate hikes that may occur this year. The Federal Reserve voted unanimously last week to raise the federal funds rate target range by 25 basis points to 3.75% — 4% to curb inflation. This is the first time that the Federal Reserve has raised interest rates since July 2023. Meanwhile, the latest bitmap shows that the Federal Reserve's policy path is being adjusted in a “higher and longer” direction — the median federal funds rate forecast to rise to 4.1% by the end of 2026, and most officials support raising interest rates at least once more during the year.

Investors currently expect the possibility that the Federal Reserve will raise interest rates again in October by more than 50%. Michael Goussey, chief investment officer of the global fixed income division of Xin'an Asset Management, said in an interview: “This probably won't end with one or two interest rate hikes.” He added, “If they actually try to control inflation by destroying demand, then [rate hikes] are likely to be even more aggressive.”

The Federal Reserve said in its policy statement that US economic activity continues to expand at a steady pace, domestic spending remains resilient, productivity growth is strong, capital investment is steady, employment growth is basically in sync with labor force growth, and the unemployment rate has not changed much; at the same time, inflation is still high, and this policy action will help push inflation back to the 2% target in a more timely manner.

Federal Reserve Chairman Walsh said at the press conference that the Federal Reserve “has withdrawn some of its easing policies” this time with the aim of making the financial and credit environment more consistent with achieving the ultimate policy goals. In particular, he stressed that prices for too many categories of goods and services are still rising at an annualized rate of more than 3%, and said that this summer's inflation data did not convince him that potential inflation trends had improved meaningfully.

The previous series of inflation data strengthened the rationale for the Federal Reserve to re-tighten its policy. Core inflation rose higher than expected in August, triggering market concerns that price pressure may be spreading from factors such as tariffs and energy price shocks to a wider range of sectors. The Federal Reserve's latest forecast shows that the median PCE inflation rate in 2026 is 3.7%, and the core PCE inflation rate is expected to be 3.4%; what is more noteworthy is that officials currently expect overall PCE inflation to return to 2% until 2029, which is further delayed from previous expectations.

Judging from the signals released by the Federal Reserve itself, the current policy focus is clearly still on controlling inflation. The official statement emphasized that inflation is still high, while economic activity remains steady, capital investment is strong, and the job market has not deteriorated significantly, which means that the Federal Reserve still has room to contain price pressure through higher interest rates. As a result, the Federal Reserve's 25 basis point rate hike last week is probably not an isolated policy adjustment. The next data on inflation, employment, and energy prices will be a key factor in deciding whether the Federal Reserve will continue to tighten its policy later this year.

After the Federal Reserve gave a signal last week that the policy might continue to tighten, the market quickly reacted. After the meeting, Michael Gapon, the chief US economist at Morgan Stanley, adjusted the forecast to a total of three rate hikes — including this one last Wednesday — higher than the two previously anticipated.

Goldman Sachs economists expect the Federal Reserve to raise interest rates by another 25 basis points in October, which changed the bank's previous expectation that September would be the only rate hike. The bank's economists also said that the meeting was more hawkish than they expected, and pointed out that the unanimous voting results and Walsh's description of the interest rate hike as “a dose of easing was lifted” reflected this.

Senior Wall Street strategist Ed Yardney cut the S&P 500 year-end target price from 8,400 points to 7,900 points last week because he expects interest rate hikes more than once this year. “The risk is that oil prices will remain high for a longer period of time and will continue to drive higher bond yields,” Adney wrote. He hinted that the current rate hike by the Federal Reserve may just be the beginning of a cycle of interest rate hikes. “The longer oil prices remain high, the greater the risk of deep-seated inflation, especially if the economy remains resilient,” he said.

In contrast, Bank of America stock strategist Savita Subramanian believes the S&P 500 index will usher in a better entry point. “We are entering a period of seasonal weakness, and in our opinion, the time has come for the market to pull back,” she said. The agency expects the Federal Reserve to raise interest rates once each in October and December this year, and slightly raise the target price of the S&P 500 index to 7,400 points at the end of the year, which means there is room for a decline of about 3% from the current level.

Wall Street strategists pointed out that despite facing multiple adverse factors, including bond yields, rising oil prices, and the strengthening of the US dollar, the S&P 500 index is still strong. Horizon Chief Investment Officer Scott Ladner said, “If some of these negative factors begin to ease and we maintain this profitability, then we are really looking forward to the fourth quarter.” Radner said investors should focus on “the second phase of the transmission of AI capital expenditure downstream effects,” such as infrastructure-related companies, which may benefit from fourth-quarter related spending.

Furthermore, in an environment of rising interest rates, Jordan Jackson, a global market strategist at J.P. Morgan Asset Management, suggests “maintaining a healthy balance between growth stocks and value stocks.” He also favors large-cap stocks over small-cap stocks because small-cap stocks are more sensitive to rising interest rates.