The risks are clearly tilted toward maintaining high interest rates for a longer period.

Written by: Long Yue, Wall Street Insights

On September 17, the Federal Reserve unanimously voted 12 to 0 to raise interest rates by 25 basis points at the FOMC meeting, adjusting the target range for the federal funds rate to 3.75%-4.00%. This was a "consistent with words and actions" hawkish rate hike: Chairman Walsh's wording at the press conference was completely in line with the hawkish tone he established at the Jackson Hole meeting.

According to reports from the trading desk, UBS promptly released a report interpreting this rate hike. The report showed that Walsh emphasized multiple times in the post-meeting press conference that current financial conditions "do not constitute a restriction," and that this rate hike merely removed "some accommodation," with wording far tougher than market expectations.

Price stability is the foundation of economic growth, and I believe we have taken an important step today to achieve it. We partly achieve this by removing this dose of accommodation.

Walsh explicitly rejected attributing any "operational significance" to the neutral interest rate, indicating that his policy framework has distanced itself from that of his predecessor. The dot plot shows that the median forecast among FOMC members anticipates one more rate hike this year, maintaining a median interest rate of 4.1% through the entirety of 2027.

UBS economist Jonathan Pingle and his team assessed that, compared to the last three or even more Federal Reserve chairs, Walsh's policy reaction function has undergone a substantial shift: he is more sensitive to financial conditions, less sensitive to the labor market's impact, and has set a higher threshold for "restrictive monetary policy." This judgment has a direct impact on market expectations for the next four years.

Three Major Variables Prompt a "Firm and Consistent" Decision

Walsh disclosed three new variables affecting decision-making since July at the press conference, breaking down the logical support for this rate hike.

• First, the labor market is strong, with the August employment report providing strong confirmation.
• Second, inflation trends are concerning, and recent CPI data have failed to provide positive signals.
• Third, geopolitical situations and their impact on energy prices.

Walsh's original words were: "The third thing that has changed in these seven weeks is geopolitics. Hotspots around the world are impossible to ignore, and our judgments about the most likely or least likely directions of the geopolitical situation have changed. All three points together pointed to today's firm and consistent decision."

He also specifically mentioned that since his appointment, he has had multiple communications with other global central bank governors — an occurrence not common in previous Federal Reserve decision-making frameworks. Analysts point out that Walsh may be more focused on policy dialogue among global central banks than his predecessor.

"Not Harming the Labor Market," But Walsh's Logic Is Different

Walsh stated at the meeting: "I don’t think we need to harm the labor market to achieve our goals. I do not believe the two components of our dual mandate — price stability and maximum employment — are at odds in the medium term."

This statement sounds mild, but the interpretation of the report is starkly different.

According to research, this is not the usual logic of "the labor market looks good, and inflation is too high," but rather Walsh believes that higher interest rates will not fundamentally impact employment expansion. His tolerance for shocks to the labor market — or indifference to it — constitutes one of the core features of his policy framework.

In other words, Walsh is not saying "I will carefully protect employment," but more like saying "rate hikes won’t harm employment, so I have no reason not to raise."

Sensitivity to Supply Shocks: A New Policy Signal

Analysts also pointed out that Walsh seems to be more sensitive to energy price shocks than previous chairs.

This may stem from his critical reflection on the Federal Reserve's mishandling during the COVID-19 pandemic. Historically, including during the 2007-2008 period, there was a view within the Fed that oil price increases should be "looked through," as energy shocks would eventually dissipate naturally. Previously, while Walsh was a Fed governor, he expressed sympathy for the stances of Charles Plosser and Richard Fisher regarding the second-round effects of oil price inflation.

Now as chair, his position has transformed. Walsh mentioned "second round effects" at the meeting — a terminology closer to the European Central Bank's policy language rather than the traditional Fed discussion framework of "energy price transmission of inflation."

This implies that Walsh is inclined to take proactive measures in the face of supply shocks, pushing inflation back to target, rather than waiting for the shocks to naturally dissipate before adjusting.

Therefore, according to the report analysis, compared to his predecessor, Walsh's reaction function presents three significant characteristics:

• First, more sensitive to financial conditions. He shows greater concern for the market than his predecessor, but in the opposite direction — he displayed clear indifference to market declines, ignoring them in his Jackson Hole speech, and showed no concern during today’s press conference.
• Second, less sensitive to the labor market. His dual mandate statement essentially downplays the binding nature of employment on monetary policy.
• Third, a higher threshold for "restrictive policy." He refuses to acknowledge that the current level of interest rates is restrictive, which means he is willing to push rates higher and maintain them longer.

UBS concluded:

Overall, compared to the past forty years, we may be facing a more hawkish FOMC reaction function, and this state will persist for the next four years.

Dot Plot: Writing Down Low Rates but Acting on High Rates

This dot plot reveals an intriguing internal contradiction.

The median forecast shows that the FOMC has raised the longer-run dot from 3.1% to 3.2%. However, the path that members actually wrote down — maintaining 4.1% in 2027, dropping to 3.9% in 2028, and further down to 3.6% in 2029 — indicates that throughout the forecast period, the nominal policy rate will always be above this long-term equilibrium point.

This indicates that "the FOMC is actually operating at a level above its nominal long-term equilibrium rate," in other words, members fundamentally believe that the real interest rate level required to achieve price stability in the next three to four years needs to be higher.

Additionally, Walsh himself again did not submit a dot — only 17 out of 18 data points extend beyond 2027. Analysts believe, "Clearly, one participant thinks that the forecast three years out has little practical value."

In terms of SEP inflation forecasts, the core PCE inflation forecast for this year has been raised from 3.3% to 3.4%, slightly exceeding UBS expectations; however, the path for the next three years aligns with a return to the 2% target. Notably, despite the significant upward revision of interest rate forecasts, GDP growth projections have also been revised upward — from 2.2% to 2.3% for 2026, and the unemployment rate forecast has been significantly lowered from 4.3% to 4.1%, with expectations remaining below the long-term equilibrium level of 4.2% throughout the forecast period.

UBS's Interest Rate Path Forecast

According to UBS research reports, its baseline forecast is as follows:

• October FOMC: Skip the rate hike (consistent with the wait-and-see mode from June to July 2026, while also avoiding a rate hike six days before the midterm elections)
• December FOMC: Another rate hike of 25 basis points
• 2027: Maintain, start cutting rates in June

However, the institution clearly stated that after today's press conference, the risks to this interest rate path are clearly tilted upward.

Walsh's attitude toward forward guidance at the press conference was also quite straightforward:

It is not my job to provide forward guidance, but my commitment in June was to reiterate to the American people and all listeners that we will achieve price stability... Today's actions begin to show that we are serious, and we will meet the price stability target, and as stated, we will do so in a more timely manner.