US Federal Reserve Raises Interest Rates Amid Rising Inflation Fears and Energy Shocks

The Federal Reserve rarely delivers one-off interest rate increases. When the US central bank raised interest rates for the first time in three years, it left Fed chairman Kevin Warsh facing a pressing question: Are more rate rises to come?

“I'm not going to prejudge any future decisions we make,” he told reporters following the announcement.

Updated forecasts released by the Federal Open Market Committee alongside its policy decision showed that a large majority of policymakers are indicating one more rate increase this year. Traders anticipate the Fed to raise rates again in December after holding steady next month, according to CME Group data.

“The key question from here is no longer whether the Fed is willing to hike, but how far it will ultimately need to go,” said Noureldeen Al Hammoury, chief market strategist at Equiti Group. “If inflation continues to surprise to the upside, the current 'dot plot' may prove to be a floor rather than a ceiling for the tightening cycle.”

The dot plot refers to the quarterly projection released by the Fed that shows where each of the 19 members on the Federal Open Market Committee believe interest rates could go in the short term. The latest projections showed a large majority of officials expect to raise interest rates by a total of 50 basis points this year.

Following the news conference, the yield on the benchmark 10-year Treasury rose more than 2 basis points to 5.025 per cent. Meanwhile, the two-year Treasury note yield, which closely tracks future Fed decisions, climbed more than seven basis points to 4.74 per cent.

The Federal Reserve's most recent major rate-rising cycle occurred in 2022 to combat increasing inflation driven by an energy shock following Russia's invasion of Ukraine, post-Covid supply chain bottlenecks, and fiscal stimulus. At that time, inflation peaked at over nine per cent, prompting the Fed to raise interest rates from near zero to a range between 5.25 and 5.5 per cent over roughly two years.

Fed officials have yet to bring inflation back down to their long-term 2 per cent target, and new price pressures are emerging from energy-driven supply shocks caused by the Iran war. Although the central bank typically looks through temporary energy inflation, oil's return to $100 a barrel and increased government borrowing led to a unanimous 12-0 vote in favour of raising interest rates.

However, Michael Pearce, chief US economist at Oxford Economics, believes the move represents risk management rather than the start of a new tightening cycle. “We don’t think this is the beginning of another major tightening cycle and markets have too much tightening priced in over the coming year,” Mr Pearce wrote.

While updated projections indicate a higher-for-longer policy posture, officials do not anticipate further rate increases next year before eventually bringing the federal funds rate down to 3.9 per cent in 2028 and 3.6 per cent in 2029. Critics note that the dot plot is merely an educated guess by individual FOMC members and has a historically poor track record for guiding markets.

Mr Warsh, an opponent of the dot plot, disclosed that he did not submit his own projection this week, having also refrained from doing so in June. Steering clear of traditional forward guidance, he stated, “I'm not into the forward-guiding business.”