Why Fed pricing may be turning too hawkish

Investing.com -- Citi analysts suggested in a note Tuesday that market expectations for Federal Reserve policy may be turning too hawkish ahead of Wednesday's decision, in which it expects a 25-basis-point rate hike.

In its base case, the bank expects the increase to be dovish in the sense that it comes with guidance pointing away from further hikes.

Citi thinks Chair Kevin Warsh will characterize the move as a "slight adjustment" or "calibration" and suggest there may be no need for further increases if inflation appears to be heading back toward target.

The bank believes parts of the Fed's updated economic projections should reinforce that impression, with the median dots likely showing just one more hike this year and cuts resuming in 2027, consistent with the view that policy rates near 4% are slightly restrictive and that the restriction should be removed as inflation eases.

“Core PCE inflation projections will likely be revised down from June, reflecting methodological revisions,” wrote the bank.

However, Citi cautioned that the biggest driver of the overall tone, and the hardest to predict, is how Warsh talks about the hike.

The hawkish risk, it said, is that he simply emphasizes there is more "work to do" without offering near-term guidance. Markets could read that as a signal that hikes are likely at both the October and December meetings, with the risk of further increases into 2027.

Citi noted that Warsh's preference for giving little guidance leaves room for markets to price in more hawkish policy than the bank anticipates.

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