Written by: Xiao Bing

Kevin Warsh raised his first knife.

At 2 PM on September 16, the Federal Reserve voted 12 to 0 to raise interest rates by 25 basis points, adjusting the target range for the federal funds rate to 3.75%-4.00%. This marks the first increase since July 2023, ending a pause in rate hikes that lasted over three years.

The market had already fully priced in this 25 basis point hike, with CME FedWatch giving a 92% probability before the vote; the real impact came from the dot plot and Warsh's press conference released afterward.

Dot Plot: A Signal More Hawkish Than the Rate Hike

The Summary of Economic Projections (SEP) and the dot plot were the true "weapons" of this meeting.

Among the 18 committee members, 12 believe another hike should occur within the year, 4 believe there should be two more hikes, and only 2 advocate for keeping the current level steady. The median point suggests the rate will be at 4.1% by the end of 2026, indicating at least another 25 basis point increase.

Forecasts further out are also hawkish: the median rate for 2027 is projected to be 3.9% (implying a possible rate cut in 2027), and the long-term neutral rate is set between 3.0%-4.0%, while PCE inflation is expected to return to the 2.0% target only by 2029.

In translation, the Federal Reserve believes the current inflation issues cannot be resolved in just one or two quarters, with rates needing to remain around 4% for at least a year before they may begin to slowly decline.

Why Now?

Warsh's remarks at the press conference were unequivocal: "Inflation is too high and has been for too long."

Data supports his assessment. In August, PCE inflation was about 3.6%, far exceeding the 2% target. Core PCE was about 3.2%, and core CPI was roughly 2.4%. Diesel prices soared to $6 per gallon. Ongoing conflicts in the Middle East are pushing energy prices higher, with no signs of relief in supply-side price pressures.

The contradiction lies in the fact that the U.S. economy itself is not weak. August's non-farm employment data was robust, corporate profits are healthy, and capital investment is on the rise. Warsh specifically mentioned this: "The decision to raise rates was made at a time when the U.S. economy appears to be strengthening."

This is what makes this rate hike unique: it occurs within an awkward range of "the economy is performing reasonably well, but inflation is stubborn." For the market, this scenario is harder to price than mere overheating because it implies that the Federal Reserve may raise rates to restrictive levels before the economy begins to slow.

Impact on Various Assets

U.S. Stocks: Short-Term Bearishness Digested, Medium-Term Focus on Dot Plot Realization

The 25 basis point increase itself had limited impact on U.S. stocks, as the market had already priced in a 92% probability. Following the announcement, the S&P 500 and Nasdaq briefly rose, a typical “bad news is good news” reaction.

However, the dot plot is the true pricing anchor. If another hike occurs this year (the median expectation), the federal funds rate will reach the 4.25%-4.50% range. This will directly pressure valuation multiples: if the yield on the 10-year Treasury follows suit upward, the rise in the discount rate on the denominator will compress the PE of growth stocks.

The structural impact is more significant: rates staying above 4% for over a year implies “higher for longer” is returning. The valuation recovery space introduced by the expected rate cuts in the second half of 2024 and the first half of 2025 is now beginning to be withdrawn.

The most direct victims are high-leverage, low cash flow growth companies. The beneficiaries are bank stocks (expanding net interest margins) and energy stocks (inflation driven by oil prices is precisely their source of income).

Gold: Short-Term Pressure but Long-Term Logic Unchanged

The rate hike boosts the dollar and real interest rates, which are two major headwinds for gold.

Following the announcement, the dollar strengthened, putting downward pressure on gold. The Fed's rate increase also directly raised the financing costs of holding physical gold, increasing inventory financing costs for refiners, jewelers, and industrial users.

However, the long-term logic for gold remains intact. The trend of global central banks buying gold is structural and will not reverse due to a single 25 basis point hike. Conflicts in the Middle East and geopolitical risks provide ongoing safe-haven demand. If inflation indeed returns to the 2% target by 2029 as predicted by the Fed, the narrative of gold as an inflation hedge will repeatedly be brought up in the market over the next three years.

Short-term selling pressure, long-term buying point, is the classic script for gold in the early stages of a rate hike cycle.

Bitcoin: Layered with CLARITY Act Failure, Double Pressure Test

Bitcoin had already fallen to $75,850 a day before the rate hike due to the failure of the CLARITY Act vote. After the rate hike announcement, BTC basically remained flat, with no further significant decline, as the market had digested most of the risk aversion the day before.

The mid-term impact on BTC depends on one core variable: the trajectory of real interest rates.

When real interest rates (nominal rates minus inflation rates) rise, the opportunity cost of holding zero-yield assets (like gold and bitcoin) increases, prompting funds to flow out of these assets. Currently, the nominal rate is 4%, with PCE inflation at 3.6%, resulting in a real interest rate of only about 0.4%, which is still quite low. If the Fed continues to raise rates to 4.25%-4.50%, and inflation falls to about 3%, the real interest rate will rise to 1.25%-1.50%, significantly increasing pressure on BTC.

But Bitcoin has its own independent narrative. The approval of the ETF in January 2024, the halving effect in 2025, and the continued growth of institutional holdings are structural variables in supply and demand that will not disappear due to a single rate hike. Even at high rates in 2023, BTC rose from $16,000 to over $40,000. The direction of rates is important, but it is never the only pricing factor.

The Fed in the Warsh Era: How Does It Differ from Powell?

This is Kevin Warsh's third FOMC meeting since taking charge of the Federal Reserve, but the first to adjust rates. In the previous two meetings (June and July), he chose to stay put, but three members had already voted in favor of a rate hike in the July meeting.

Warsh and Powell have two significant differences:

He refuses to provide forward guidance to the market. The Fed during Powell's era would anticipate the next steps by adjusting the wording, while Warsh explicitly rejects this approach. This means that every FOMC meeting could become a moment of suspense, structurally increasing market volatility.

He is more concerned with inflation than employment.

Powell repeatedly emphasized the "dual mandate" during the 2021-2022 rate hike cycle, leaning towards slowing down the tightening pace when employment data worsened. Warsh's press conference today focused almost entirely on inflation, with only a passing mention of the strength in the job market. This suggests that even if employment data weakens in the future, Warsh may not pivot as quickly as Powell.

When asked whether Trump influenced the rate hike decision, Warsh directly denied it. Trump repeatedly pressured the Fed to lower rates throughout his second term, while today’s decision pushed rates in the opposite direction. This remote battle is far from over.

Many investors have spent the past two years trading on the assumption that the downward trend in rates is irreversible. Duration has lengthened, PE valuations have expanded, and leverage ratios have increased. Today's rate hike breaks this assumption. If inflation indeed returns to the 2% target by 2029 as projected by the dot plot, the rate environment for the next three years will be far more complex than the expected rate cut channel in 2024-2025.

For investors, there is only one core conclusion: do not bet on the direction of rates, hedge against rate volatility. In a world where inflation is stubborn, the economy is not weak, and the Federal Reserve Chairman refuses to provide forward guidance, every FOMC meeting could change the anchor for pricing.