The Fed's interest rate hike tonight is almost a done deal, but the key is "what is said after the hike."

Written by: Dong Jing, Wall Street Insights

Wall Street is holding its breath waiting for Wednesday's Fed rate decision. Citigroup and Goldman Sachs rarely align closely in their core assessments: this interest rate hike is almost certain, but it will be a "dovish hike" — the hike itself is not the main focus, the main focus is what the Fed says after the hike, or what it doesn’t say.

According to news from the momentum trading desk, Citigroup's latest research report on September 15 indicates that the baseline forecast shows that the Fed will define this rate hike as a "calibration" and suggests that there is no inevitability of further hikes in the future. Goldman Sachs noted in its research report on September 13 that tonight's hike will be a "no signal hike" and explicitly stated that it does not believe this hike has sufficient economic justification, attributing the portion of inflation exceeding the 2% target entirely to one-off factors, and that the economy is not overheating.

Both Citigroup and Goldman Sachs expect that the median dot plot will show only one additional hike remaining in 2026, with rate cuts to resume in 2027. The core PCE forecast is expected to be revised down from June data due to methodological revisions, providing data support for stopping the hikes.

Despite the dovish baseline scenario, the press conference by Chair Walsh will be the biggest suspense for the market. Citigroup believes that if Fed Chair Walsh refuses to provide clear forward guidance and only emphasizes "there's more work to do," the market may reprice consecutive hikes in October and December, leading to significant asset price volatility. Goldman Sachs thinks Walsh needs to emphasize in the press conference that the committee will "carefully assess" upcoming data to imply waiting for more information, guiding the market to abandon excessive confidence in a hike in October.

Analysts believe that the key tonight is not "to hike or not to hike," but "what is said after the hike." Every word from Walsh will be scrutinized by the market under a magnifying glass.

Dovish Baseline Scenario: Passive Rate Hike and "Calibration" Tone

The current market pricing has forced the Fed to make a choice. Goldman Sachs believes that after the announcement of the August CPI data, the probability of market pricing for a hike has approached 90%, and the Fed will be compelled to raise rates by 25 basis points at this meeting to avoid a sharp market reaction from inactivity.

However, this will be a thoroughly dovish action. Citigroup's baseline forecast indicates that the forward guidance accompanying the rate hike will no longer point to further increases in the policy rate.

Fed Chair Walsh is likely to downplay the increase in the policy rate as a "slight adjustment" or "calibration" and suggest to the market that if inflation shows signs of retreating to the target, further hikes may not be necessary.

Goldman Sachs also expects that the Fed will only make the minimum necessary modifications in the statement to avoid providing forward guidance on future paths, effectively presenting a "no signal hike."

It is worth noting that Goldman Sachs expects Fed Governor Waller to cast a dissenting vote. The reason is that the annualized rate of core PCE inflation over the past three months (including the impact of methodological revisions) has dropped to about 2.5%, below the "hold steady" threshold of 2.8% previously set by Waller in public.

Goldman Sachs: Does Not Believe this Rate Hike Has Sufficient Economic Justification

Different from Citigroup's strategic analytical perspective, Goldman Sachs' economic research team starts from the fundamentals and explicitly states that it does not believe there is sufficient economic reason for this federal funds rate adjustment.

Goldman Sachs' core argument is that the entire amount of inflation exceeding the 2% target can be attributed to one-off factors that will fade away, including tariff effects, energy/Iran conflict impacts, software and component price effects, and portfolio management effects. Goldman Sachs believes that the improvement of core PCE inflation to an annualized rate of about 2.5% from June to August (including expected methodological revisions) is an early sign of the fading of these one-off shocks.

On the breadth of inflation, Goldman Sachs similarly holds dissenting views. Although recently more categories have increased in price at an annualized rate exceeding 3%, Goldman Sachs points out that once tariff effects are excluded, the breadth of inflation is basically equivalent to levels during historical 2% inflation periods — and the tariff shock has likely largely settled.

Furthermore, Goldman Sachs' "Bottlenecks Tracker" indicates that industry-level capacity constraints are now slightly lower than before the pandemic and are mainly concentrated in a few industries closely related to the AI boom. The economy is not overheating — and economic overheating is precisely the core reason for usually raising interest rates.

Macroeconomic evidence also suggests that limited increases in interest rates are unlikely to effectively offset larger inflation effects caused by supply shocks. This means that regardless of whether the Fed raises rates, its main policy logic remains to wait for the effects of past shocks to gradually dissipate over time.

For this reason, Goldman Sachs believes that some FOMC members have a high degree of consensus with their inflation judgments, and the FOMC as a whole is unwilling to emit any further signals of rate hikes at this meeting.

SEP Economic Forecast: Dot Plot and Core PCE Downgrade as Dovish Support

Several components of the Summary of Economic Projections (SEP) will collectively reinforce this dovish impression.

Citigroup points out that the median dot plot will show only one additional hike this year, with rate cuts resuming in 2027. This path aligns with the current internal logic of the Fed: a policy rate around 4% is considered "slightly restrictive," and as inflation returns to target, this restriction should gradually be lifted.

Goldman Sachs' assessment of the dot plot distribution is also specific and precise: it is expected to show a narrow majority of 10 votes to 8 votes for only one hike in 2026 (with Waller and possibly other members voting for zero hikes). Goldman Sachs gives this judgment reason: some members hold contradictory attitudes toward this hike itself, and some members do not wish to further raise market expectations for additional hikes.

However, Goldman Sachs also clearly points out tail risks: if more members see this week's hike as a normal response to rising oil prices and AI demand and view it as the beginning of a series of hikes, the risk of a majority vote supporting two hikes cannot be ignored.

In terms of inflation predictions, both institutions expect that the core PCE inflation forecast will be revised downward due to methodological revisions. Goldman Sachs expects the mid-forecast for core PCE inflation in 2026 in the September SEP to slightly reduce from 3.3% in June to 3.2%, which provides data support for stopping rate hikes.

Walsh's Press Conference: The Market's Biggest Suspense

Despite the dovish baseline scenario, Citigroup warns that the most important and unpredictable variable determining the overall tone is how Chair Walsh discusses this rate hike. Walsh's personal style tends to provide less forward guidance, leaving significant room for the market to price more hawkish policies.

Citigroup believes that if Walsh merely emphasizes "there's more work to do" without providing recent rate guidance, this may be viewed by the market as a dangerous signal. In this hawkish risk scenario, the market may expect that both the FOMC meetings in October and December will raise rates and may extend the pricing of further hikes into 2027.

Goldman Sachs' judgment on this scenario is more specific: the FOMC may wish to guide the market to lower its pricing confidence for an October hike (currently close to 50%), but will not explicitly state it in the statement. Instead, Walsh may indicate in the press conference that the FOMC will "carefully assess" the upcoming data before deciding on further actions or may wish to see multiple (plural) inflation reports about to be released or observe how potential inflation trends evolve — any of these statements will imply that the committee wishes to collect more data over a period before taking action.

Goldman Sachs also adds that since many investors have considered the midterm elections in early November as a political obstacle to an October hike, it is not difficult to prevent the market from making the October hike the "default baseline."

Goldman Sachs has set three scenarios:

• Baseline scenario (probability 50%): only one hike (this one), with cuts in September and December 2027, and a terminal rate of 3.25%-3.5%;
• Multiple hikes scenario (probability 35%): ultimately raising rates two to three times, with a higher terminal rate;
• Recession scenario (probability 15%): economic downturn, monetary policy shifts.

Even fully considering the tail risks of the multiple hikes scenario, Goldman Sachs' probability-weighted federal funds rate predictions are still much more dovish than the current market pricing. Goldman Sachs also adjusted its terminal rate forecast from previously 3%-3.25% to 3.25%-3.5% and pushed back the timing of the first rate cut in 2027 from June to September.

Moreover, Citigroup particularly points out that the recent sharp fluctuations in WTI crude oil and average gasoline prices in the U.S. add extra complexity to the inflation outlook and the Fed’s policy path. If energy prices remain high, they may shake the Fed's judgment that "inflation has moved toward the target," thereby strengthening the position of more hawkish members.