Instant Insights: Fed sets sights on inflation | Insight Investment

The Federal Reserve (Fed) unanimously voted for a 25bp rate hike, taking the Fed Funds range to 3.75% to 4%. This was its first hike since July 2023.

We believe there may be more hikes to come, but with markets already pricing them in, it may be a good time for investors to start seeking opportunities to lock in fixed income yields.

Are markets right to price in multiple further hikes?

In addition to today’s hike, the Fed’s median updated “dot plot” projections now reflect one more rate hike in 2026.

Current market pricing, however, reflects another three hikes over the next 12 months, a steeper trajectory (Figure 1). In our view, up to three hikes may represent a reasonable base case, so markets may therefore present attractive opportunities to lock in higher yields.

Figure 1: Markets are pricing in a steeper rate hiking trajectory than the Fed’s own median projections¹

Fed narrows in on inflation mandate

Chair Warsh emphasized the Fed’s commitment to the central bank’s inflation target. He noted the labor market side of its mandate is “in good shape … so our predominant focus is on the price stability side”.

The FOMC’s official statement noted the rate hike is intended to “support a timelier return” to its 2% inflation target. Warsh added “We must be confident that underlying inflation is moving toward our objective, clearly and at sufficient speed”.

Core inflation measures have run above 2% for 66 months straight (Figure 2). Although core CPI has eased in recent months, core PCE (the Fed’s preferred measure) has uncharacteristically been running higher, partly due to a higher weighting to software and accessories, posing challenges to the Fed.

Figure 2: The Fed signaled a commitment for a more timely return to 2% inflation²

More hikes could be on the agenda

Warsh also stated that the Fed was removing a “dose of accommodation” with the hike. He also continued to characterize the economy as strengthening, attributing recent rises in Treasury yields primarily to the growth environment. The committee’s official statement also continued to note “domestic spending has been resilient. Productivity growth is strong, and capital investment is robust”.

In our view, this is more likely to indicate that a traditional hiking cycle, rather than a policy recalibration, will be needed to bring inflation back to target. This would suggest the underlying strength of the economy will determine the number of rate hikes the Fed will need.

With markets potentially already priced for rate hikes, and the Fed committed to controlling inflation, we believe it could be a good time to look for compelling entry points into fixed income assets.