Markets Digest Rate Hike Amid Light Earnings Slate

Keith Lansford (0:05)

Welcome to the Schwab Market Update Podcast, where we prepare you for each trading day, with a recap of recent news and a look at what's ahead.

I'm Keith Lansford, and here is Schwab's Early Look at the Markets for Thursday, September 17th. Investors head into today, still digesting the implications of the Federal Reserve's first rate hike in more than three years. With a light earnings and economic calendar through the end of the week, contention will likely remain on the path forward for rates amid elevated treasury yields, oil prices and geopolitical tensions. The Fed raised its benchmark interest rate by 25 basis points yesterday in a widely expected and unanimous decision, pushing its target range to between 3.75% and 4%. It's very unlikely this will be a one-and-done, and quite likely the Fed will hike again, said Colin Martin, head of fixed income research and strategy at the Schwab Center for Financial Research. From an economic perspective, 25 basis points isn't going to do too much, but it sends a message. The decision to hike rates came after US crude oil prices surged above $100 per barrel this month amid the Iran conflict. Growing hostilities in Yemen have also added to the upward pressure on crude in recent weeks by threatening key shipping lanes near Saudi Arabia. US consumers are feeling the impact of these conflicts. The average price of a gallon of gasoline hit $4.36 on Wednesday, while diesel prices had a record high of $6.31 per gallon, according to the American Automobile Association. Inflation has also been above the Fed's 2 percent target for more than five years now, and the August monthly core consumer price index, which excludes food and energy prices, topped expectations at 0.3 percent. That might have been the final straw for a Fed that's been patient for many months. Our predominant focus is on the price stability side of our mandate. The plain fact is that inflation is too high and has been for too long, Chairman Warsh told reporters in his post-meeting press conference. This summer's inflation readings do not tell me that underlying trends have meaningfully improved. Warsh seemingly set the table for yesterday's hike in his Jackson Hole speech last month when he promised to not let inflation get out of hand. The question now is whether the Fed might have more rate hikes up its sleeve, and the market appears to think so. After Wednesday's decision, futures trading priced in a nearly 90% chance of at least one more hike before the end of the year, according to the CME FedWatch tool. The odds of two additional hikes surged above 35%.

Checking the Fed's so-called dot plot of rate projections, the average estimate for the end of 2026 came in at 4.1% compared with 3.8% in June. While Chairman Kevin Warsh has chosen not to submit a dot since taking on his new role, 16 of the 18 other voting Fed officials expected another hike this year, with 4 of those seeing 2 more hikes as possible. For 2027, the average rate projection was 4.1% compared with 3.6% in June, suggesting another hike next year will depend on the pace and outlook of inflation moving back towards 2%.

The Fed also delivered its inflation expectations and gross domestic product or GDP estimates yesterday. It pegged the 2026 headline and core personal consumption expenditures or PCE price index growth at 3.7% and 3.4% respectively on a year-over-year basis. Those projections were a touch above June's estimates of 3.6% and 3.3%. For 2027, it sees headline and core PCE prices matching June's estimates of 2.3% and 2.5% respectively. The central bank also expects real GDP to hit 2.3% in 2026 and 2.4% in 2027, up slightly from June's estimates. And finally, now it sees a median unemployment rate of 4.1% in both 2026 and 2027, compared with 4.3% for both years in June.

Major indexes plunged and treasury yields rose across most of the curve yesterday after the hawkish Fed meeting. The 10-year treasury yield pushed back above 5% after touching that level for the first time since 2007, earlier this month. From a bullish perspective, while oil prices have pushed back higher over the past six weeks, the consumer remains resilient and bond yields are higher but not running away, said Nathan Peterson, Director of Derivatives Research and Strategy at the Schwab Center for Financial Research. However, from a bearish near-term trading perspective, the most important leading indicator is the state of the Iran War, in my view, and it doesn't appear to be going very well. While the Fed was in focus yesterday, there were multiple major economic reports that also garnered tension. Some of these appeared to signal inflation remained an issue in August. For instance, August US export and import prices rose 0.6% and 0.7% respectively, the Bureau of Labor Statistics reported. However, the August Retail Sales Report was a bright spot in some respects. Retail sales rose 1.2% month over month, topping the 0.8% consensus estimate. The closely watched Control Group retail sales figure, which feeds into the government's gross domestic product estimate, climbed 1.4%.