Why Fed pricing may be turning too hawkish

Citi analysts have expressed concern that market expectations for the Federal Reserve's monetary policy may be becoming overly aggressive before their upcoming decision, set for Wednesday. The bank anticipates a 25-basis-point rate hike during this meeting, but is optimistic that it will be characterized as a "slight adjustment" or "calibration", possibly indicating no further increases if inflation trends back toward the target.

Citi believes the Fed's revised economic projections, which suggest just one more rate hike this year and rate cuts resuming in 2027, should support this view. These projections assume that policy rates near 4% are somewhat restrictive, and that this restriction should be lifted as inflation eases.

However, Citi warns that the most significant factor driving the overall tone, and the most unpredictable element, is Chair Kevin Warsh's characterization of the hike. The bank notes that Warsh's tendency to emphasize that more work is needed, without providing near-term guidance, could lead markets to interpret this as a signal for additional hikes at the October and December meetings.

This could in turn drive further rate increases into 2027. Citi points out that Warsh's reluctance to offer much guidance leaves room for markets to price in a more hawkish policy than the bank is anticipating.