Barclays has sharply revised its outlook for U.S. monetary policy, now expecting the Federal Reserve to raise interest rates by 25 basis points in September and again in December after Chair Kevin Warsh delivered his strongest indication yet that policymakers may need to tighten policy to contain inflation.
The shift marks a significant change from Barclays’ previous forecast that the Fed would leave rates unchanged for the remainder of the year. The brokerage said Warsh’s speech at the Federal Reserve’s annual Jackson Hole symposium was “notably hawkish” and provided an implicit case for further monetary tightening.
Warsh stopped short of signaling when rates might move, but said the Fed would “have work to do” if policymakers could not gain sufficient confidence that underlying inflation was moving toward the central bank’s 2% target.
“Here is my standard: We must be confident that underlying inflation is moving to our objective, clearly and at sufficient speed. Otherwise, we have work to do. That’s our job,” Warsh said.
“The Fed’s predominant focus right now should be on prices.”
The remarks mark an important change in the policy debate. For much of the year, investors had been focused on the possibility of rate cuts as inflation appeared to moderate and concerns about economic growth increased. Warsh’s comments instead put the risk of renewed or persistent inflation at the center of the Fed’s decision-making.
He also argued that financial conditions are not currently restrictive enough and said the labor market remains consistent with full employment. That combination gives the Fed more room to prioritize price stability without an immediate need to cushion a weakening labor market.
Barclays said it continues to expect monthly inflation readings to be “much softer” than the longer-term measures emphasized by Warsh. However, the brokerage warned that unfavorable base effects could make the broader inflation picture look less encouraging through the end of the year.
That creates a potential problem for markets. Even if monthly price increases moderate, year-over-year inflation can remain elevated when comparisons with the previous year’s prices become less favorable. For the Fed, sustained inflation above its 2% target could therefore matter more than a handful of softer monthly readings.
Markets have already begun adjusting to that possibility. Interest-rate futures were pricing a 60.4% probability of a September rate hike, according to CME Group’s FedWatch tool, indicating that investors now see a rate increase as more likely than not.
The repricing also underscores how consequential Warsh’s remarks were. He explicitly said his comments should not be interpreted as “forward guidance,” but investors nevertheless took them as a warning that the bar for keeping rates unchanged could be rising.
The September decision will ultimately depend on the inflation and employment data released before the Federal Open Market Committee meeting on September 16. A continued deterioration in inflation could strengthen the case for a hike, while evidence of cooling price pressures could give policymakers room to wait.
Barclays’ call for another increase in December is more significant because it implies the inflation problem could persist beyond the September meeting. Under that scenario, the Fed would not be responding to a temporary increase in prices but to evidence that inflation is failing to converge toward its target quickly enough.
Warsh also challenged the idea that keeping rates unchanged is necessarily a neutral position. With financial conditions still relatively accommodative and credit markets showing few signs of significant restraint, maintaining the policy rate could allow demand to remain strong enough to sustain price pressures.
The implications extend beyond interest rates. A more hawkish Fed could keep Treasury yields elevated, increase corporate borrowing costs, and put pressure on equity valuations, particularly in sectors whose valuations depend heavily on future earnings.
That risk is particularly relevant after a period in which long-term Treasury yields have already climbed sharply. Higher yields can make government bonds more attractive relative to equities while raising the discount rate investors use to value future corporate cash flows.
For businesses, the consequences could also become more pronounced if the Fed follows through with two hikes. Higher financing costs would raise the hurdle rate for investment and could force companies to reassess capital spending, acquisitions and other projects dependent on debt financing.
The policy shift could be especially important for the technology sector, where companies have committed enormous sums to artificial intelligence infrastructure. Much of that investment depends on expectations of strong future returns. Higher interest rates can increase the cost of financing that expansion and put greater pressure on companies to demonstrate that their AI spending will generate sufficient revenue and profits.
The Fed is therefore confronting a difficult balance. Cutting rates too quickly could risk allowing inflation to become entrenched, while maintaining or raising rates could eventually weigh more heavily on economic activity and investment.
Warsh’s Jackson Hole remarks are seen as an indication that, for now, the inflation side of that equation is carrying greater weight.
Barclays’ revised forecast puts the September 16 meeting at the center of the market’s attention. If incoming data fail to provide the “confidence” Warsh said policymakers require, analysts expect the first rate increase to come sooner than investors had expected. If inflation remains stubborn through the autumn, a second hike in December could follow.
