Why Markets May Be Pricing in Too Many Fed Rate Hikes

PodcastGoldman Sachs ExchangesRobert KaplanSep 23

Kaplan sees a possible September rate move followed by a pause, with further action depending on inflation and the oil shock; he says markets may be pricing in more hikes than he considers likely. He points to strong AI investment and defense spending alongside weakness in interest-sensitive sectors, and argues that rate increases may have limited effect on those areas. Persistent supply shocks and higher-than-expected deficits add uncertainty, while the yield curve reflects fiscal concerns and oil prices.

Interest Rates Monetary Policy Inflation Market Valuations Fiscal Policy Energy Markets

Preview · 7 more points in the app

Read the Full Summary

Key Takeaways

Kaplan favors a September hike, probably no October move absent a reason to act, and a December reassessment; two increases from 3.75%–4% would bring rates to his estimated nominal-neutral range of 4%–4.25%. He says monthly inflation near 3%, versus the Fed’s hoped-for pace of roughly 0.2%, supports action, while firmer inflation readings or a supply shock that persists for six to eight months and spreads to 30 or 40 items could change the timing or case for further tightening.

Kaplan says markets are pricing more hikes than he thinks likely, partly reflecting uncertainty about Kevin Warsh’s reaction function and the risk that the Iran war keeps oil elevated; he says prolonged high oil could spread its effects to 30 or 40 items. He also says higher oil has affected the yield curve, but the curve had already priced in more increases than the Fed may deliver, helping explain why the September hike had little effect on it.

Kaplan links a muted Fed dot plot—one more increase at the median and no action in 2027—to strong AI infrastructure and adoption activity, while autos and housing remain sluggish or weak. He argues rate increases are unlikely to slow the AI build or defense spending, and says AI is accelerating a shift toward a larger corporate profit share of GDP, supporting company resilience and margin prospects.

ECONOMY

Rate Path — Kaplan says he would favor a move in September, probably skip October absent a reason to act, and reassess in December. Two hikes from the current 3.75%–4% range would put rates at 4%–4.25%, around his estimate of nominal neutral. He is unsure whether much more tightening would be needed because interest-sensitive parts of the economy are not overheating. Firmer inflation or worse-than-expected CPI or PCE readings could instead prompt October action.

“And if I were on the committee, my mindset would be, let's move in September…”—

Inflation Readings — Kaplan says month-over-month inflation was running closer to 3%, above the roughly 0.2% monthly pace the Fed hoped to see, equivalent to about 2.5% annualized. He says the hotter readings supported beginning to take action.

“The thing that was problematic is the month-over-month numbers. I think they were hoping that those would cool and start to approach say 0.2 a month. So annualized 2…”—

Fed Projections — Kaplan describes the dot plot as signaling a relatively muted response: a median of one more increase and no action in 2027. He links that outlook to strong AI infrastructure and adoption activity. Defense spending is also strong, he says, while interest-sensitive areas such as autos and housing are sluggish or weak.

“And I think the dot plot interestingly was pretty muted, showed a pretty muted response, meaning they're going to raise in September.”—

MARKETS

Hike Pricing — Kaplan says markets are pricing in more hikes than he currently thinks likely, partly as a risk premium for uncertainty about Kevin Warsh's reaction function and the possibility that the Iran war keeps oil prices elevated. Prolonged high oil could increase the chance of its effects spreading to 30 or 40 items, he says.

“I think the market is yes, expecting more hikes than at the moment, at the moment, I think is likely.”—

Yield Curve — Kaplan says the lack of an announced fiscal plan is affecting the back end of the yield curve. Bond buybacks may buy time or mitigate the problem at the margin, but he says the market does not view them as a solution.

“And the second thing is there hasn't been any fiscal plan announced. There've been bond buybacks announced, but I think the market reaction is that isn't gonna solve the problem…”—

September Rate Hike

Kaplan supports the September increase because monthly inflation remained hot, while noting that booming AI investment and defense spending contrast with sluggish interest-sensitive sectors.

Fed Rate Path

Kaplan expects a possible September move followed by a pause and a fresh look in December, and says markets may be pricing in more hikes than he considers likely.

Fed Independence

Kaplan says FOMC participants are making decisions without political pressure, while acknowledging that markets are still scrutinizing the new chair.

Treasury Yields And Deficits

Kaplan attributes higher long-term yields partly to larger deficit projections and the absence of a fiscal plan, while oil prices have lifted yields across the curve.

Profits And Labor

Kaplan says Fed speeches offer insight into policymakers’ debate and points to rising corporate profits alongside weaker gains for workers without financial assets.

Supply Shocks And Inflation

Kaplan argues that prolonged, recurring supply shocks can spread inflation to other prices, so rate increases may help limit that transmission; he favors gradual action unless data worsen.