What's Behind the Fed's Rate Hike?

PodcastOn InvestingLiz Ann SondersSep 18

The FOMC's 25-basis-point hike was aimed at speeding progress toward its 2% inflation target, while the latest projections do not show another hike in 2027. Speakers also discuss how AI investment may add to demand-side inflation pressure and how longer-term Treasury yields shape borrowing costs and equity-market behavior. Treasury yields, a flattening curve, and competition for capital remain important risks, though Lizanne says a larger equity impact would likely require a more disorderly market or a sharp rise in Treasury volatility.

Monetary Policy Interest Rates Inflation

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Key Takeaways

The Fed’s 25-basis-point hike was framed as a way to support a timelier return to its 2% inflation target, not as a response to reaccelerating inflation, even as the economy strengthens. Lizanne argues that inflation pressure also reflects demand from AI-related capital expenditures, while the Atlanta Fed’s inflation-adjusted GDP nowcast rose to 5.1% after stronger retail sales.

Colin says the Fed’s median projection does not show another hike in 2027, but eight officials project one and he cautions that the dots are not a guarantee. Lizanne distinguishes the rate channels: the Fed funds rate affects short-term yields and money-market income, while mortgage rates track longer-term Treasury yields; she argues that any help from tighter policy in lowering mortgage rates would come over time, not immediately.

Lizanne links the S&P 500’s negative reaction after the press conference to the 10-year yield moving back above 5%, and says a large, disorderly spike in Treasury volatility could have a more meaningful equity-market impact. Separately, Colin links the more hawkish-than-expected meeting to a rise in the 2-year yield to about 4.74%; Lizanne says the resulting curve flattening hit banks and is a leading indicator for the broader, especially consumer, economy.

ECONOMY

Fed's Inflation Rationale — The FOMC raised rates by 25 basis points, its first hike since 2023. The move was expected and drew no dissents. Colin says inflation remains too high and progress toward the Fed's 2% target is slow, even as the economy strengthens, the labor market remains stable, and unemployment declines. He says the Fed acted to support a timelier return to the target—not because inflation was reaccelerating or the target was unreachable.

“We are recording this very shortly after the Federal Open Market Committee or FOMC meeting where the Fed voted to raise interest rates, and it's the first rate hike that…”—

Rate Projections — Colin says the Fed's median projection shows no additional rate hike in 2027, although eight officials project one more hike that year. He cautions that the dots are point-in-time projections, not a guarantee.

“That's a point in time projection from each committee member. And if we look ahead to 2027, for example, the projection in 2027 does not project…”—

Inflation Pressures — Lizanne argues that inflation pressure is not solely supply-driven. AI-related capital expenditures are adding demand pressure that feeds into consumer prices, while labor supply is the top concern in the latest NFIB survey. She cautions that the labor component is nowhere near a wage-price spiral.

“But there's a demand side component of this too…”—

MARKETS

Yields And Stocks — Lizanne links stocks' negative reaction after the press conference to the 10-year yield moving back above 5%. She says that yield tends to matter most to equities as a driver of direction and volatility.

“Well, we obviously saw a negative reaction by, stocks in the somewhat immediate aftermath of the press conference, and that shouldn't come as a surprise given the move back up…”—

Curve Flattening — Colin links the more hawkish-than-expected Fed meeting to a sharp rise in the 2-year Treasury yield, which was about 4.74% after the meeting and press conference. Lizanne says the yield curve flattened and banks were hit. She describes this as a leading indicator for the broader economy, particularly the consumer economy.

“On the equity reaction, I can point to the treasury market and I think what caught the markets off guard when you look at the two year treasury yield jumped…”—

FORECASTS

Treasury Volatility — Lizanne says a 5% 10-year Treasury yield reflects nominal growth, inflation, and Fed expectations, and that the move has been relatively orderly. She says a more disorderly market or a large spike in Treasury volatility could have a more meaningful impact on equities.

“And I think that's because, you know, a five percent ten year yield is reflective of what's going on in the economy from a nominal growth standpoint, from an inflation…”—

Fed's 25-Basis-Point Hike

Colin says the Fed raised rates because inflation remains above target despite a resilient economy and stable labor market, aiming to speed a return to 2% inflation.

Fed Projections and Rate Path

The projections show somewhat stronger growth and higher inflation, with inflation still above target in 2028 and a hawkish tilt toward another hike, though no median hike is projected for 2027.

AI Demand and Inflation

Lizanne links inflation pressure to supply disruptions and demand from AI investment, while strong retail sales and GDP estimates help explain the relatively orderly equity-market reaction.

Treasury Yields and Stocks

The hosts discuss how a hawkish Fed surprise, rising Treasury yields, and a flatter curve can pressure stocks, while Lizanne says a disorderly bond market or volatility spike could cause greater equity damage.

Competition for Capital

Colin attributes higher long-term yields to strong growth and competition for capital, while noting that government debt is a longer-term concern rather than the main near-term driver.

Borrowing Costs and Inflation

The hosts explain that many consumers' borrowing costs track longer-term yields, and that a credible Fed response to inflation could eventually help lower mortgage rates.

Upcoming Data and Fed Speakers

Colin previews returning Fed commentary and economic surveys, while Lizanne highlights labor-market releases and explains why she follows S&P Global's PMI surveys alongside ISM's.