Citi sees Fed delivering "a dovish hike" next week

Citi's analysts foresee the Federal Reserve raising interest rates by 25 basis points to a range of 3.75%-4% during the upcoming Federal Open Market Committee meeting next week. They classify this move as a "dovish hike" as recent inflation data has provided just enough support for tightening, despite underlying details pointing towards gradual disinflation.

This leaves open the possibility that the Fed could keep rates steady while awaiting more data, or that some officials may dissent from the decision to hike. The meeting will also feature updated economic projections, with Citi forecasting that the median estimate for 2026 core Personal Consumption Expenditures inflation will be revised down from 3.3% in June projections to closer to 3% on a quarter-to-quarter basis.

GDP expectations are expected to remain largely unchanged, while unemployment rate expectations are anticipated to be slightly lower. With a rate increase in September, Citi expects the median dot plot to signal one additional hike this year, totaling two increases. The recent core consumer price index data came in slightly stronger than expected at 0.29% month-over-month, resulting in a comparable core PCE reading.

Citi believes the reading, coupled with a rise in oil prices, is sufficient to prompt a hike, although they consider it a tight call due to other details in the report suggesting further disinflation. In his Jackson Hole speech, Fed Chair Kevin Warsh highlighted that inflation has persistently been above target and emphasized the need for further work if it does not slow down quickly enough.

He used this opportunity to support a hike if core PCE annualizes at 3.5% on the month. Fed Governor Christopher Waller, on the other hand, has been more dovish, attributing his cautious stance to two months of cooler inflation readings. However, he indicated that a hawkish reading would lead him back to a September hike. Citi expects Warsh and Waller to be joined by three regional Fed presidents who dissented in favor of hikes in July, along with several other governors, resulting in a hike with minimal dissent.

Warsh might describe the decision as a "calibration" rather than the start of a new hiking cycle. Citi also expects retail sales to rebound in August, with both headline and core sales rising 0.7% month-over-month. Industrial production is projected to post another solid gain, while single-family housing starts are anticipated to recover after a weak July reading. Jobless claims are projected to remain historically low.