Central Bank Rate Decision Looms: Markets Price In Tightening While Equities Surge on AI Optimism

The Federal Reserve is set to convene the Federal Open Market Committee (FOMC) on the 15th and 16th to deliberate on a potential policy rate increase. Markets are currently pricing in a nearly 90% probability of a hike. On Friday the 11th, U.S. financial markets experienced a surge in equities and a pause in the ascent of long-term yields, reflecting growing investor conviction that growth driven by the artificial intelligence (AI) sector remains robust despite expectations of tighter monetary policy to curb inflation.

Should a rate hike be approved, it would mark the first increase in three years and two months, dating back to July 2023. The Federal Reserve’s decision is also expected to influence the yen exchange rate. Market participants are closely watching what Chair Warsh will communicate regarding the rate outlook during the post-FOMC press conference.

Inflation data released this week underscored the persistent nature of price pressures. The Personal Consumption Expenditures (PCE) Price Index, the Federal Reserve’s preferred inflation metric, increased by 3.7% year-over-year in July, remaining significantly above the 2% target. The August Consumer Price Index (CPI) also rose by 3.4%. Concurrently, August Nonfarm Payrolls—a crucial indicator of economic health—rose by 162,000 from the previous month, demonstrating continued resilience in the labor market.

Against this macroeconomic backdrop, Chair Warsh stated in a late August speech that if inflation is not brought under control toward the 2% target, “there is work to be done,” keeping the possibility of a rate hike firmly on the table. These remarks bolstered market expectations that a hike is inevitable. Tsubasa Fujiwara, a researcher at Daiwa Institute of Research, commented that if the Fed fails to act at this meeting, it “would be inconsistent with the Chair’s remarks.”

In the U.S. bond market on the 11th, the 2-year Treasury yield, which is highly sensitive to policy rate expectations, rose by as much as 0.06% from the previous session’s close. Meanwhile, the 10-year Treasury yield, which is strongly correlated with inflation expectations, briefly approached the 5% threshold before quickly reversing lower. As the benchmark long-term yield showed signs of stabilizing, a sense of relief permeated the equity market.

In the stock market, buying was broad-based, with the Dow Jones Industrial Average—comprising blue-chip stocks—closing up 509.19 points at 52,573.29. Trading activity was particularly concentrated in AI and semiconductor-related stocks. A Japanese securities firm observed that “long-term yields have stabilized, and a sense of reassurance has spread.”

While rate hikes typically weigh on equity markets by increasing corporate financing costs, the current environment presents a different dynamic. Expectations that tightening monetary policy will successfully control inflation have alleviated concerns about the economic outlook, with growth expectations centered on the AI industry providing underlying support. Ahead of the FOMC decision and Chair Warsh’s press conference, the market has already priced in a rate hike while attempting to discern the trajectory of monetary policy beyond it.

The latest readings of key economic indicators are as follows:

Note: The PCE Price Index serves as the Federal Reserve’s preferred gauge for its inflation target.

The FOMC decision will be announced following the two-day meeting on the 15th and 16th. Market attention is focused not only on whether a hike occurs, but also on the Chair’s message regarding the future pace of tightening and the inflation outlook.

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