Macro
Four reasons behind our higher Fed interest rate forecast
We now expect the US Federal Reserve (Fed) to raise rates by a further 75 basis points by the second quarter of 2027, taking the federal funds target range to 4.5-4.75%. This is 50 basis points higher than our previous forecast. We continue to expect one additional 25 basis points increase by the end of 2026.
Our revised view follows the Federal Open Market Committee’s (FOMC) September meeting, at which it raised the federal funds target range by 25 basis points to 3.75-4.0%.
The Fed is no longer giving forward guidance, creating uncertainty about the timing and magnitude of future moves. Even so, recent comments from Fed Chair Kevin Warsh point to further tightening, and we see four developments supporting a higher terminal rate.
1. Financial conditions remain too accommodative
Mr Warsh has made broader financial conditions central to how the Fed assesses policy.
At the Jackson Hole Economic Policy Symposium in August, he said he was “hard-pressed to describe broad financial conditions as restrictive”. He repeated this view during September’s FOMC press conference, where he noted that it was “widely shared by the committee” and that the Fed had therefore “removed a dose of accommodation”. Mr Warsh also indicated that the highly uncertain neutral interest rate should play a more limited role in guiding policy. This changes both the starting point for policy and the benchmark against which future tightening is assessed.
The hawkish tilt is reflected in the FOMC’s dot plot. The median policymaker expects one further 25 basis points hike this year and no additional move in 2027. However, four participants expect two further hikes in 2026, while eight anticipate a total of 50 basis points of further tightening by the end of 2027. The median long-run dot – an indication of the FOMC’s estimate of the longerterm neutral rate – has risen to 3.25%.
2. A no-landing economy is not delivering sufficient disinflation
Mr Warsh highlighted the recent strengthening of the economy. Consumer spending remains resilient, labour market conditions are solid, productivity growth has improved and business investment remains robust.
But inflation remains elevated and has been above target for more than five years. Mr Warsh stressed that the underlying trend had not improved meaningfully and remained too broadbased. Rising commodity prices add another upside risk.
The FOMC’s September economic projections highlight the tension. The median projection is for real GDP growth of 2.3% this year and 2.4% next year, with unemployment holding at 4.1% throughout the forecast horizon. However, inflation is expected to decline only gradually. Core personal consumption expenditures (PCE) inflation is expected to ease from 3.4% this year to 2.5% next year and 2.2% in 2028, before reaching the 2% target only in 2029.1
In our view, the no-landing economic backdrop makes the inflation outlook harder to call. With growth above potential and employment still strong, inflation is unlikely to return sustainably to target without some cooling in the economy. Structural pressures compound that challenge. Mr Warsh has argued that lower inflation does not need to mean weaker employment, but we think that trade-off will become harder to avoid as policy tightens.
3. Credibility and independence remain important
The September rate increase came amid renewed political scrutiny of the Fed. The FOMC’s unanimous vote in favour of a rate hike is a reassuring sign of institutional resilience and independence, underscoring the committee’s willingness to follow its economic assessment.
More broadly, recent US Treasury interventions to try to contain long-term yields underscore the risk of rising tensions between fiscal and monetary policy. With inflation still too high, the Fed needs to match its tough talk with action to regain credibility and deliver on its dual mandate of price stability and maximum employment.
4. Inflation comes first
Since his nomination as Fed chair, we have viewed Mr Warsh as an orthodox inflation hawk with a more dovish view of the economy’s supply potential. His priorities and sequencing are now clearer: inflation must be addressed first. Stronger mediumterm productivity growth, including from AI-related investment, could lift the economy’s growth potential, but it is not a substitute for bringing current inflation under control.
At Jackson Hole, Mr Warsh said underlying inflation needed to move towards the 2% target clearly and at sufficient speed. In September, he judged that this test had not been passed. The rate hike was presented as a necessary step to reduce support for the economy and help inflation return to target sooner, rather than as a technical response to a higher neutral rate or a symbolic move to bolster credibility.
Outlook: September’s rise is the first step in a longer hiking cycle
The Fed has begun to take support out of the economy, moving policy to a tighter stance. The September increase is likely to be the first step in a longer cycle rather than a one-off move. Financial conditions still support growth, the economy remains resilient, and inflation is the Fed’s main concern. The need to reinforce its commitment to price stability also points to further rate rises.
1 Source: Summary of Economic Projections, US Federal Reserve, 16 September 2026.
