The Federal Reserve tried to calm the market with "one more time," while Wall Street investment banks and traders have already stirred up tremendous differences.

Source: Jinshi Data

On Thursday, the Federal Reserve raised interest rates for the first time in over three years, and now Wall Street and the market are wildly guessing: how many more times will the Federal Reserve raise rates next?

The dot plot still regards "one more time" as the baseline scenario

The latest economic forecast from the Federal Reserve offers a relatively restrained median path. Among the 18 officials who submitted forecasts, 16 expect at least one more rate hike this year; the median corresponds to an end-of-year rate rising to 4.00%—4.25%, and maintaining the same level by the end of 2027. By this measure, there is only one subsequent rate hike of 25 basis points.

Federal Reserve Chair Waller described this rate hike at the press conference as "withdrawing some of the accommodation," rather than pushing the policy further into a clearly restrictive area for the economy. He also mentioned that geopolitical conflicts and energy shocks have become factors that have altered policy judgments in recent months.

This phrasing has attracted attention in the bond market. If the decision-makers believe that the policy following the rate hike still does not significantly restrict demand, then there is potential for the rate endpoint to continue to rise.

At the same time, the Federal Reserve has raised some inflation and neutral interest rate forecasts. The neutral interest rate is the theoretical level that neither stimulates nor suppresses the economy. After the neutral rate judgment moves up, the degree of tightening represented by the same nominal policy rate will correspondingly decrease, which also makes the extra rate hike in the dot plot appear less aggressive.

However, the dot plot does not provide a baseline scenario for continuous rapid tightening. Kay Haigh, head of fixed income at Goldman Sachs Asset Management, judges that the Federal Reserve has not yet signaled a round of aggressive rate hike cycles, and its baseline judgment remains to hike once more in December.

Morgan Stanley worries about stronger inflation stickiness

Nevertheless, there are still Wall Street investment banks that "do not buy it." Morgan Stanley further turned hawkish after the meeting. The bank's chief U.S. economist, Michael Gapen, adjusted the current forecast to a total of three rate hikes, including the one completed this week, with subsequent hikes expected in December and March next year, each by 25 basis points, giving a terminal rate of 4.25%—4.50%.

The bank pointed out that the reasons center on three aspects: the pace of cooling in inflation is insufficient, economic activity remains resilient, and decision-makers no longer view energy shocks simply as transient factors that can wait to fade away.

Currently, U.S. crude oil and refined product prices remain high. Waller stated that the Federal Reserve has changed its judgment on global conflicts and their impact on energy, no longer assuming that this shock will pass quickly. The rise in prices of refined products such as diesel also increases the possibility of energy costs being passed through to transportation, goods, and business operating expenses.

Morgan Stanley noted that the economy itself has not yet provided a clear signal forcing the Federal Reserve to stop rate hikes. Discussions following the Federal Reserve meeting still indicate that domestic spending, employment, and capital expenditure are holding up. In particular, AI investments, with large financing scales, are not highly sensitive to changes in short-term interest rates by several basis points.

This suggests that the transmission of monetary policy may more heavily impact traditionally rate-sensitive sectors. Mortgage loans, auto loans, general corporate financing, and discretionary consumption will first feel the higher cost of capital, while large AI projects and energy investments may not cool down synchronously. Gapen believes that if inflation remains high, and rate hikes become the main tool, financial asset prices may first bear adjustment pressure before affecting consumption.

Therefore, Morgan Stanley expects that after the Federal Reserve raises rates in December, it may still take action in March next year. If this judgment materializes, the policy rate will rise to 4.25%—4.50%, which is 25 basis points higher than the median path in the dot plot.

The market is more hawkish than investment banks and the Federal Reserve

In contrast, market pricing has gone further. On Thursday, interest rate futures briefly factored in about three additional 25 basis point hikes over the next year, significantly higher than the median of the dot plot.

The market pricing also added risk premiums beyond the policy path. Interest rate futures not only reflect the most likely outcomes of meetings but also account for scenarios such as oil prices rising again, core inflation spreading, and economic growth remaining strong.

Thursday's market pricing indicated that traders believed there was over a 50% chance that the Federal Reserve would raise rates again in October, with even higher probabilities in December. If action is taken in October, the market would still retain room to tighten further in 2027. It is worth noting that futures prices change daily based on data, oil prices, and risk preferences, and the market accounting for two additional rate hikes over the dot plot reflects thicker tail risks for inflation, not that investors are certain that three additional hikes will definitely occur.

The next round of inflation data, energy prices, and economic activity indicators before the October meeting will directly determine whether these three levels of expectations can realign.