The Federal Reserve’s 25-basis-point interest rate increase last week was widely expected. The more important message was that the policy reaction function is becoming clearer.
The decision was unanimous. That matters because it gives Fed chair Kevin Warsh institutional cover at a time when the administration has been pushing for easier policy. This was not a narrow or contested move. The committee as a whole judged that inflation and the resilience of activity justified tighter policy.
The projections reinforced that message. The median dot points to one further increase in 2026 and no cuts in 2027. More strikingly, inflation is not expected to return to the 2% target until 2029. That is the key macro signal from the meeting.
If the Fed’s forecast is broadly right, the US will have spent roughly eight years with inflation above target before price stability is restored. That is closely aligned with the regime embedded in our own long-term capital market assumptions, where we have for some time expected inflation to remain more persistent and to settle above the norms investors became accustomed to after the global financial crisis.
Structural change
The point is not simply that inflation is taking longer to fall. The structure of the economy has changed. Geopolitical fragmentation, energy security, larger fiscal footprints, supply-chain duplication and the capital intensity of the AI investment cycle all point towards a world in which inflation is likely to remain more persistent.
The Fed’s own projections are increasingly acknowledging that reality. Warsh’s press conference was also hawkish and broadly consistent with his Jackson Hole message. He note the Fed had removed a dose of accommodation, implying he still sees rates as below short-term neutral.
“If the Fed’s forecast is broadly right, the US will have spent roughly eight years with inflation above target before price stability is restored.
Inflation remains above target, activity is resilient and capital spending is strong. Unless that combination changes, further tightening remains on the table.”
Inflation remains too high and the Fed needs clearer evidence it is moving towards target at sufficient speed. Until then, the bias remains towards tighter policy.
There was still no conventional forward guidance. Still, compared with July, the reaction function is easier to read. Inflation remains above target, activity is resilient and capital spending is strong. Unless that combination changes, further tightening remains on the table.
The response at the long end is worth noting. Long-term treasury yields have fallen despite the hike and the hawkish dots. That is constructive but it is too early to draw strong conclusions about credibility. At the very least, markets have not treated the meeting as adding to long-term inflation risk.
Bigger question
The bigger question is how far the cycle goes. Our working assumption remains that this becomes a three-to-four-hike cycle rather than a single adjustment. That view, however, is conditional on the AI capital expenditure cycle remaining intact.
AI investment is supporting demand today even as it may raise productivity over time. The spending required for data-centres, semiconductors, power, grids, infrastructure and financing is large enough to matter for the macro cycle. As long as that investment remains strong, the US economy may be able to absorb higher rates more easily than a conventional late-cycle framework would suggest.
Read more on this from Wealthwise: What can bond investors take from Jackson Hole?
If AI capex rolls over materially, though, the calculation changes quickly. Growth becomes more vulnerable to further tightening and the Fed would have to reassess the balance of risks.
For now, the message is fairly simple. The Fed has resumed tightening, the committee is united and the dots suggest the cycle is not finished. More importantly, the Fed is now projecting a much longer period of above-target inflation, consistent with the structural inflation regime we have embedded in our capital market assumptions.
The policy path will still depend on the data – however, if the AI investment cycle remains intact and inflation stays persistent, we continue to think this tightening cycle has further to run.
Salman Ahmed is global head of macro and strategic asset allocation at Fidelity International
