TL;DR
· The market widely expects the Fed to raise rates by 25 basis points to 3.75%-4.00% this week, which would be the first rate hike since 2023.
· The real suspense is not this rate hike itself, but whether it is merely a policy calibration or the starting point of a new rate-hiking cycle.
· The bond market has already front-run a more hawkish policy path, so what deserves more attention at this FOMC is the dot plot, Warsh's remarks, and the subsequent rate path.

The rate hike is no longer the biggest suspense

Market expectations for a Fed rate hike this week are rapidly approaching consensus.

According to Investopedia, the market now widely expects the Fed to raise the federal funds rate target range to 3.75%-4.00% this week. CME FedWatch data shows that traders have priced in a 93% probability of a rate hike this time. If it materializes, this would be the Fed's first rate hike since 2023 and also the first since Kevin Warsh became Fed Chair.

The direct reason driving the rapid hawkish shift in policy expectations is still inflation.

U.S. August CPI rose 3.4% year over year, still clearly above the Fed's 2% target. In the view of some institutions, continuing to keep rates unchanged in the current environment could instead weaken the Fed's policy credibility in fighting inflation. Ian Lyngen, head of U.S. rates strategy at BMO Capital Markets, argued that in the current inflation environment, it would be hard for the Fed not to leave the market with the impression of "insufficient willingness to fight inflation" if it does not raise rates this week.

But the problem is that, as a 25-basis-point rate hike is increasingly fully digested by the market, "whether to hike" is no longer the biggest suspense.

What truly determines the market's next direction is what happens after the rate hike.

The bond market has already been trading "more rate hikes" in advance

Before the Fed formally acts, the bond market has in fact already completed a round of repricing ahead of time.

The 10-year U.S. Treasury yield recently broke above 5%, rising noticeably from below 4.5% in early July, while at an earlier stage its yield was even below 4%. At the same time, the average rate on 30-year U.S. mortgages has also risen back above 7%.

This means the market is now trading not just this week's 25 basis points, but whether the Fed will continue tightening in the coming months.

Precisely because of this, the meeting could produce a seemingly counterintuitive situation: the Fed raising short-term rates does not necessarily mean long-end yields will continue to rise.

Mark Cabana, head of U.S. rates strategy at Bank of America, believes that if Warsh can prove to the market through a hawkish rate hike that the Fed is willing to act on inflation, it could actually reduce investors' fears of long-term inflation spiraling out of control.

In other words, higher short-term rates could theoretically help push down long-term inflation expectations and ease pressure on long-end yields to continue rising. This is also why this week's market reaction may not depend on the "rate hike" itself.

If the Fed merely mechanically delivers the 25 basis points already priced in by the market without giving a sufficiently clear anti-inflation signal, the bond market may not calm down as a result; conversely, if the Fed successfully reinforces policy credibility, the market could even see a reaction of "short-end hike, long-end stabilization."

Therefore, the more central question for this FOMC has become: Is the Fed completing a policy recalibration, or launching a new rate hike cycle?

"One and Done," or Just the Beginning?

Wall Street is clearly divided on this. One camp believes this week's rate hike is more like a policy recalibration rather than the starting point of a new cycle.

James Knightley, chief international economist at ING, points out that rising oil prices do pose a new inflation risk, but there are still a series of factors within the U.S. economy that could help bring price pressures down, including slowing job growth, moderate wage pressures, a weak housing market, and partial tariff refunds reducing pressure on businesses to continue raising prices.

Therefore, ING believes inflation could still move back toward the 2% target next year, and this rate hike is more of a "recalibration" rather than the restart of a sustained tightening cycle.

But another group of institutions is clearly more hawkish.

Peter Williams, an economist at 22V Research, believes the Fed has now reached the point where it should restart rate hikes. He expects that beyond this week, the Fed may continue raising rates in December and in the first half of 2027.

The rationale behind this view is that U.S. economic growth remains solid, consumers remain resilient, the AI investment boom is still ongoing, global supply-side shocks are occurring frequently, and overall financial conditions have not yet tightened enough to significantly suppress demand.

These two sets of judgments imply completely different interest rate paths for the market.

If this week is merely a risk-management-style policy adjustment, then the market may soon restart discussions about an economic cooldown and the possibility of resuming rate cuts in 2027. But if the Fed signals that this is only the first step in a new round of tightening, then Treasuries, mortgages, corporate financing costs, and highly valued risk assets could all continue to face upward pressure on interest rates.

Therefore, even if the Fed raises rates by 25 basis points as expected this week, the real incremental information still comes from "what's next."

The dot plot may be more important than the rate hike itself

To judge the Fed's next move, the market will first look at the dot plot.

After this week's meeting concludes, the Fed will release its quarterly economic projections and the latest dot plot, reflecting FOMC members' individual judgments on the future policy rate.

Although Warsh himself has not been enthusiastic about the dot plot in the past, the forecasts of the other 18 officials will still become an important basis for the market to judge the remaining two meetings this year. The Fed will subsequently hold two more policy meetings in late October and December.

Compared with the median of the dot plot, another important signal this time is whether the divergence among officials further widens. BMO believes that if the dot plot shows two clear camps—some officials supporting continued rate hikes, while others believe this action is already sufficient—then the policy path in the coming months will instead become even harder to judge.

This divergence has already begun to appear.

At the July meeting where rates were kept unchanged, three committee members voted against holding steady; at the same time, relatively dovish officials represented by New York Fed President John Williams believe that some signs have already emerged showing that the energy price shock has not yet clearly spread to broader price levels.

This means that even if the Fed ultimately succeeds in raising rates this week, there may not yet be a stable internal consensus on "whether to continue afterward."

The market also needs to hear what Warsh says

In addition to the dot plot, another key variable is Warsh's wording at the press conference.

TD Securities U.S. economics head Oscar Muñoz believes that Warsh may not provide the market with very clear forward guidance. But even if he does not directly say "there will be another rate hike next time," if he continues to repeatedly emphasize inflation risks, the market may still interpret such remarks as: further tightening remains a realistic option.

Conversely, if the dot plot itself leans dovish and Warsh does not explicitly emphasize the need to continue fighting inflation, the market may quickly lower its expectations for further rate hikes.

BNP Paribas Chief U.S. Economist James Egelhof also believes that if the number of officials supporting continued rate hikes is fewer than the market expects, Warsh may need to proactively emphasize that this week's rate hike does not mean policy action ends there, in order to prevent the market from once again questioning the Fed's determination to fight inflation.

Therefore, what is truly noteworthy about this week's FOMC may not be the 25 basis points that the market has already traded on repeatedly.

From U.S. Treasury yields to mortgage rates to risk asset valuations, more and more assets have already begun repricing in advance for a "higher for longer" rate environment. What the Fed truly needs to answer for the market is whether this repricing has gone too far, or not far enough.

A rate hike looks like a done deal, but what happens next matters more.

The market needs to find answers from the dot plot, Warsh's press conference, and divisions within the FOMC: is this merely a policy calibration aimed at inflation risks, or the beginning of a new tightening cycle.

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