Goldman Sachs revised its interest rate hike forecast for this week, not because the economy has changed, but because the market has priced it in at 90%, and the Federal Reserve may not want to create surprises. Walsh may use the majority opinion of the FOMC as cover to raise rates seven weeks before the midterm elections without bearing the brunt of Trump's anger.

Written by: Xiao Yanyan, Jinshi Data

Wall Street's assessment of the Federal Reserve's September meeting is quickly turning. Goldman Sachs unexpectedly overturned its previous prediction of maintaining the interest rate, changing it to forecast a 25 basis point rate hike by the Federal Reserve this month.

The judgment from Goldman Sachs is not due to a significant reassessment of the U.S. economic outlook, but mainly due to a change in market pricing. The firm believes that with investors highly betting on a rate hike, Federal Reserve policymakers may be reluctant to create surprises by delaying the hike.

The CME FedWatch tool shows that the market currently expects a 25 basis point rate hike by the Federal Reserve in September with an 87% probability, compared to around 70% before the latest batch of U.S. data was released last Friday. The market is also betting that the Federal Reserve may raise rates again in December.

Goldman Sachs stated that the recent surge in oil prices may further influence policymakers' judgments, making some officials more inclined to support tightening policies.

This change occurs at a time when U.S. inflation concerns are resurfacing. Stronger-than-expected producer price data, combined with Brent crude oil breaking back above $100 per barrel, has prompted investors to reassess inflation risks.

In the past week, Houthi attacks on Saudi infrastructure have heightened market concerns about energy supply. Brent crude then broke above $100 per barrel, reaching its highest level since May.

Last Friday, U.S. diesel prices surpassed $6 per gallon for the first time. The continuous rise in energy costs has also increased the risk of inflation transmitting further into other areas of the economy.

The U.S. August CPI did not show a significant cool down. Data released by the U.S. Bureau of Labor Statistics indicated that the August CPI annual inflation rate was 3.4%, the same as in July.

Walsh faces Trump: Raise rates or maintain policy credibility?

The policy divergence between Federal Reserve Chairman Walsh and President Trump also makes the September meeting particularly sensitive.

Walsh stated last month at the Jackson Hole Symposium that price growth has become "more concerning." He also warned that if inflation does not cool quickly, rate setters will have "work to do."

Previous official information indicated that Walsh had stated there would be a reason to avoid a rate hike only if there were meaningful improvements in inflation. However, the latest data did not provide such a clear signal.

Former Federal Reserve Vice Chairman Roger Ferguson believes that the likelihood of the Federal Reserve taking action this week has significantly increased. He told CNBC: "If Walsh and his colleagues want to maintain their credibility, everything points to September as the time to act."

Michael Feroli of JPMorgan pointed out that Walsh has repeatedly signaled a strong intolerance for inflation. If the Federal Reserve does not take action, it may face risks to its institutional credibility.

David Mericle of Goldman Sachs believes that policymakers also need to consider market reactions. He stated that the Federal Reserve may worry about the potential market reactions from not delivering on a rate hike that the recent communication has almost fully priced in.

Mericle also noted that Walsh's remarks at Jackson Hole have formed a market expectation that if inflation data is "not perfect," the Federal Reserve will raise rates. "While the CPI is not concerning, it is not perfect," he said.

This is also one of the important reasons Goldman Sachs changed its forecast: the market has already viewed a rate hike as a highly likely outcome, and if the Federal Reserve suddenly remains inactive, it may instead cause a greater market shock.

Trump calls for rate cuts, but the market bets on rate hikes

Trump has consistently called for lower borrowing costs and reiterated last Sunday that the U.S. should have "the lowest interest rates in the world."

The tension between Trump and Walsh is further compounded by the timing of the midterm elections. If the Federal Reserve implements its first rate hike in three years a few weeks before the November midterm elections, it may further anger the president who wishes to lower financing costs.

Trump has also stated that Walsh "wants to do the right thing" regarding interest rates, but may be hindered by a "politicized" and "hostile" Federal Open Market Committee. This means that if the Federal Reserve ultimately raises rates, Trump may not directly point the blame at Walsh himself.

However, the election timing still makes this policy decision more complicated. Analysts warn that raising rates seven weeks before the midterm elections, which will determine Congress control for Trump's second term, could still frustrate the president.

Gregory Daco, chief economist at EY Parthenon, believes that the Federal Reserve should not delay policy action to avoid elections.

He stated: "Delaying a rate hike until after the midterm elections, just like tightening for the sake of policy credibility, should not be and is not part of policymakers' debate, although it has become a core discussion in the market."

Daco expects that the Federal Reserve will ultimately raise rates because most Federal Open Market Committee members believe the pace of disinflation is "unsatisfactory."

He also judges that Walsh may leverage the positions of the majority of committee members to reduce the pressure he faces, "using the majority opinion as cover, leading from the back and voting in support of the rate hike."

For the market, the September rate hike itself is increasingly close to consensus. What is truly concerning is whether the Federal Reserve led by Walsh can stick to its own judgment and act under the multiple pressures of Trump demanding low rates, inflation still above target, and energy prices rising again.