Fed Hikes Rates to Combat Persistent Inflation

The Federal Reserve's 25 basis point rate hike on September 16 marks its effort to bring inflation back to its 2% target. The decision reflects a solid pace of economic expansion, despite geopolitical uncertainty. The median projections suggest one more hike by the end of this year.

Market expectations for four hikes over the next 12 months may be overstretched, given lagging pipeline pressures from earlier energy and tariff shocks on core inflation. Additionally, rising costs of semiconductors and information processing equipment will likely take a toll in a few months' time.

The Fed's projections imply a higher real policy rate is needed to bring inflation back down to its target. The Summary of Economic Projections now forecasts core PCE price index inflation at 2.2% and the fed funds rate at 3.9% in 2028, up from 2.1% and 3.4% previously.

The decision to hike rates was overdue, with inflation risk rising and market pricing of inflation increasing expectations for a higher terminal federal funds rate. This has contributed to widening nominal bond yields across the U.S. Treasury yield curve.