Fed delivers hawkish hike, dollar rallies but gold recovers

Warsh defies Trump as Fed raises rates

The Federal Reserve raised interest rates on Wednesday for the first time in three years, lifting the Fed funds rate by 25 basis points to a range of 3.75%-4.00%. Investors priced in the move after the August data for payrolls, PPI and CPI all surprised to the upside, giving the new chair, Kevin Warsh, little choice but to make good on his pledge to restore price stability.

But the hawkish shift didn’t stop there. The FOMC statement pointed to a “solid pace” of economic growth, “elevated” inflation, and the need for a “timelier return” to the 2% target. More importantly, most Fed officials see at least one more 25-bps hike this year, with nine committee members pencilling in another one for 2027.

The decision is likely seen as removing any doubt about Warsh’s stewardship at the Fed being influenced by his close relationship with President Trump. But whilst the Fed’s credibility received a major boost in financial markets, Trump didn’t waste any time in criticising the move, demanding that interest rates be lowered to 1% or less.

One positive for Warsh is that Trump didn’t name him directly, but the criticism is only likely to get harsher as the Fed tightens policy further over the coming months.

Hawkish Fed spooks markets but there’s also relief

Markets whipsawed in the aftermath, with Wall Street’s major indices plunging around 1% as the hike was announced. Both the euro and yen slipped by about 0.6% against the US dollar, gold skidded by more than 2%, while Treasury yields jumped higher.

The two-year Treasury yield hit the highest since July 2024, climbing above 4.7% and the 10-year yield also edged higher, but the 30-year yield spiked lower, signalling investors have more faith in the Fed keeping a lid on inflation longer term.

This slight flattening of the yield curve is probably welcome by the Fed. But most of yesterday’s moves are being reversed or pared back today, suggesting some relief that the Fed wasn’t even more hawkish.

Namely, futures markets are pricing in almost three additional 25-bps increases by January 2028 as opposed to the Fed’s median projection of just one. Moreover, FOMC members’ PCE inflation forecasts were only slightly revised higher. Fed officials are probably hoping that by acting early, inflation won’t stray much further from their 2% goal.

But Kevin Warsh’s press conference told a different story, hinting that financial conditions are not restrictive enough and describing the hike as the removal of “a dose of accommodation”. Crucially, Warsh said there are too many categories of goods and services where inflation is running above 3%.

The fact that the decision was unanimous also suggests that there’s few remaining doves in the FOMC. Yet, gold is staging a strong recovery today, rising 1.5% to $4,325, up about $100 from yesterday’s low. The dollar, meanwhile, is paring some of its gains, easing to around 155.85 against the yen and $1.1468 to the euro.

Wall Street off lows as oil retreats

Even equities are rebounding on Thursday. S&P 500 futures are up 0.75%, while Nasdaq futures are currently 0.9% higher. Optimism around AI and the broader economy has likely put a floor under the selloff. There’s a risk that this optimism will be put to the test if the 10-year yield makes its way back above 5% again, but the decline in oil prices during the past couple of sessions is helping to calm fears about high inflation.

WTI oil futures have pulled back from Tuesday’s four-month high of $106.71 to stand around $101.70 today. Brent crude has also retreated from its highs after last week coming close to breaking above $110.

The pullback comes as Bloomberg reports that Saudi Arabia is hoping to restore half the capacity of the East-West oil pipeline that was damaged by the Houthis within days and have it fully operational in six weeks. In addition, Saudi Arabia is ramping up its crude exports via Oman.

However, this may only be a temporary boost to supply as further disruptions cannot be ruled out amid the ongoing fighting in the region, and the relatively modest drop in oil prices reflects this.

BoE to stand pat ahead of BoJ hike

But with the Fed decision out of the way and fewer headlines out of the Middle East this week, the focus is now on the Bank of England. Although the UK central bank is not expected to raise rates today, policymakers will likely feel emboldened by the Fed and strike a more hawkish tone, potentially flagging a hike in November.

The pound is steadier today following the post-Fed slide, trading around $1.3385.

The Bank of Japan is also in the spotlight as it meets on Friday and is widely anticipated to tighten policy for a second time this year.