NextFin News - Raising interest rates this month would restore the Federal Reserve's credibility as an inflation fighter, argues Stephanie Aliaga, a global market strategist at JPMorgan Asset Management — a stance that puts the bank's research team ahead of a market that is only tentatively pricing in tightening. With the federal funds rate held at 3.50%–3.75% and inflation still running well above the central bank's 2% target, the question is no longer whether policymakers are behind the curve. It is whether they are willing to pay the market and political cost of catching up.
The argument lands at a moment of unusual uncertainty for the central bank. Chair Kevin Warsh, in his first months leading the Fed, has signaled a hawkish tilt without committing to a specific path, and the committee's own projections have drifted toward tightening even as the market hedges. A rate increase in September would be the first since 2023, ending a cutting cycle that brought the policy rate down from its 5.25%–5.50% peak. Reversing from easing back into tightening is the hardest maneuver a central bank can attempt: it tells markets that the pause was not a pause at all, but a mistake.
The Credibility Argument and Where the Market Stands
The credibility thesis rests on a simple asymmetry. The Fed's preferred inflation gauge, the personal consumption expenditures price index, stood at 3.7% on a 12-month basis in the latest reading, while the six-month change ran at 4.1% — more than double the central bank's target and accelerating rather than cooling. Short-term interest-rate futures, by contrast, imply only about a 60% chance of a quarter-point hike at the September meeting, according to the CME Group's FedWatch tool. That is a coin flip, not a conviction.
JPMorgan's own forecast sits between the market's hesitation and the most hawkish voices on the committee. The bank expects a 25-basis-point increase in December, with the funds rate then held at 3.75%–4.00%, while flagging that a September move remains on the cards if inflation continues to heat up. In a note published after the July meeting, the bank wrote that Warsh's remarks had "cast doubt on the new chair's credibility in delivering lower inflation," adding that this could increase the urgency for the rest of the committee to act on its mandate.
"A central bank seen to tolerate above-target inflation on the promise of a future productivity windfall can put that anchor at risk," St. Louis Fed President Alberto Musalem said in a speech.
That warning captures the credibility thesis in a single line. The anchor in question is the public's expectation that the Fed will return inflation to 2%. Once that anchor slips, the cost of bringing inflation down rises, because households and firms begin to build higher inflation into wages, prices, and contracts today. The historical lesson is unforgiving: the Fed did not break the inflation of the 1970s until it was willing to damage credibility by acting before the data forced its hand.
The committee's own median projection points in the same direction. Nine of the 18 members of the Federal Open Market Committee penciled at least one rate hike for this year in their June projections, and the median forecast for the end of 2026 sits at 3.8% — a quarter percentage point above the current target range. That is not a committee waiting for permission from the data; it is a committee that has already decided the data will oblige it to move.
Is This Inflation Cyclical — or a Regime Shift?
The entire debate turns on one classification that most commentary blurs: is the current inflation a cyclical energy shock that will mean-revert, or a structural regime shift that will not correct on its own? Getting this wrong flips the conclusion, because the correct policy response to a cyclical spike is patience, while the correct response to a structural shift is preemption.
The cyclical case is strong on its face. The consumer price index rose 3.4% year over year in July, down from 4.25% in May, and the monthly print was a mild 0.1%. The acceleration has been driven largely by energy and food prices — the rebound in oil after the renewed Iran conflict, which pushed the average U.S. gasoline price to about $4 a gallon in July, and supply-constrained fuel costs. Energy shocks are the textbook cyclical inflation: they spike, they fade, and a central bank that hikes into them risks tightening against a price move that would have reversed on its own.
But the structural signals are harder to dismiss. Core services inflation excluding energy — the "supercore" category the Fed watches most closely — surged 0.30% in May, the worst month-to-month reading in more than two years, and has been accelerating since the previous fall. The six-month PCE run-rate of 4.1% sits above the 12-month figure, which is what acceleration looks like: the trend is not just high, it is getting higher. And the committee's near-majority hawkish tilt is a forward-looking signal that policymakers see persistence, not a one-off impulse.
Here is the mechanism that separates the two cases. An energy-driven cyclical spike raises the price level once; it does not permanently raise the inflation rate unless it spills into wages and broader services. A structural shift, by contrast, shows up in the persistence of core measures and in the inflation expectations embedded in longer-dated assets. On that test, the evidence is mixed but tilting toward persistence: supercore services are broadening, the six-month trend is rising, and the committee's own median forecast has moved toward tightening.
The correct call, then, is not one or the other but both, separated by horizon. The cyclical leg is the energy impulse, which will fade as oil markets stabilize. The structural leg is the services persistence, which will not self-correct and is the part that justifies a credibility-restoring hike. A central bank that waits for the energy component to roll over before acting on the services component is, by definition, behind the curve on the part of inflation that matters most.
The Second-Order Consequence: What a Hike Actually Transmits
The first-order effect of a 25-basis-point hike is mechanical: the funds rate moves to 3.75%–4.00%, and short-dated Treasury yields follow. That is the part everyone sees. The second-order transmission is where the real story lives, and it runs through three channels that compound into something larger than the headline move.
First, the dollar. A Fed that hikes while other major central banks hold or cut widens the rate differential in favor of dollar assets. That strengthens the currency, which is itself disinflationary through cheaper imports, but also a headwind for the roughly half of S&P 500 revenue that comes from outside the United States. The exchange rate is the transmission belt that exports U.S. monetary policy to the rest of the world — and imports disinflation back home.
Second, the yield curve and financial conditions. The 10-year Treasury yield has already risen more than 80 basis points since the start of March, reaching 4.79% in early September, as investors price a higher-for-longer path. A confirmed hike would push term premium higher still, tightening mortgage rates, corporate credit spreads, and commercial real estate refinancing conditions. This is the channel through which a 25-basis-point policy move becomes a much larger effective tightening: the Fed moves the front end, and the market does the rest of the work.
Third, and most important, the expectations channel. This is the credibility mechanism in action. A preventive hike — one delivered while growth is still solid and the labor market is adding jobs, as August's 162,000 payrolls showed — signals that the Fed is acting from strength. A reactive hike — one delivered after inflation has clearly escaped — signals the opposite. The market reads the timing, not just the size.
There is a trap in the conventional wisdom here. The consensus view is that a hike is bad for risk assets because it tightens financial conditions. That is true at the first order. But the second-order question is whether the hike is priced as preventive or reactive. In 1994, the Fed's preemptive tightening initially rattled bonds but bought a long expansion with contained inflation. In 2022–2023, the Fed's delayed response required a far more aggressive cycle and produced the fastest tightening in decades. The difference was not the number of basis points; it was the credibility of the timing.
The Strongest Case Against Hiking
The counter-thesis is not weak, and it deserves its full weight. Hiking into a slowing labor market risks a policy error that a credibility argument cannot easily undo. August's 162,000 payroll gain was the strongest monthly increase since March and far above the roughly 53,000 economists had expected, but prior-month revisions have shown more muted underlying trends, and the unemployment rate has been little changed at 4.1% — a level that historically precedes deterioration rather than stability. Deutsche Bank and other forecasters expect only 50 basis points of hikes across September and December, a measured path rather than a shock, precisely because they recognize the growth risk.
There is also the question of what a hike would cost the Fed if inflation does roll over on its own. The July CPI print of 0.1% month over month shows that disinflation can still arrive without additional tightening. If the energy impulse fades through the autumn, as cyclical theory predicts, a September hike would look in hindsight like a move against a phantom — and credibility would be damaged by the very action meant to preserve it. Goldman Sachs and Barclays, among others, continue to expect the central bank to keep rates unchanged through the end of the year, a view that rests on exactly this reading of the data.
The regional banking stress of 2023 is the ghost at this meeting. Rapid tightening against a yield curve that had already done much of the work contributed to the failure of several lenders when unrealized losses on long-duration securities came due. A Fed that hikes into a curve that is already inverted and into a banking system still digesting duration risk is repeating a transmission mechanism that has already proven fragile. The 10-year yield near 4.79% has already done a significant share of the tightening the Fed would otherwise have to deliver itself.
The falsifying signal for the credibility thesis is concrete: if core PCE prints at or below 0.2% month over month for two consecutive months, the argument that the Fed must act to preserve its inflation-fighting reputation collapses. At that point, the persistence leg of inflation would be demonstrably broken, and a hike would be tightening against a disinflation that is already underway.
What to Watch: Scenarios Across Time Horizons
Short term, the market will move on the August CPI release due this week. A headline print near 0.4% month over month with core at 0.2% — the preview from Natixis's U.S. economics team — would likely be read as hot enough to keep the September hike in play but not hot enough to force a larger move. Anything materially above that lifts the probability well past 60% and reprices the entire curve. The Cleveland Federal Reserve's own inflation nowcast has pointed to a similarly hot August headline, which keeps the hawks' case alive even as the monthly trend moderates.
The base case is a 25-basis-point hike in September followed by a data-dependent pause, with a second move in December if services inflation does not cool. That path takes the funds rate to 4.00%–4.25% by year-end and is consistent with what the committee's median projection has been signaling since June. It is the path that balances the credibility argument against the growth risk — a small, early move that preserves optionality.
The upside case for hawks is two consecutive hikes — September and December — with a third in early 2027 if the six-month PCE run-rate stays above 4%. The downside case is a hold in September if the next two inflation prints come in soft, pushing the first hike to December or later and forcing the Fed to rebuild credibility through words rather than actions. That last outcome is the one Aliaga's argument is designed to prevent: a central bank that talks hawkishly but acts slowly teaches the market to discount its words.
For investors, the asymmetry is clear. Beneficiaries of a credibility-restoring hike are the dollar, short-duration fixed income, and banks that earn more on net interest margin as the front end rises. The exposed are long-duration growth equities, commercial real estate, and any borrower refinancing into a higher rate environment. The S&P 500, up more than 11% in 2026 as of early September, has rallied on the assumption that the Fed's next move is distant; a confirmed tightening path tests that assumption directly, even as strong corporate profit growth has so far absorbed the pressure from rising yields.
The bottom line is that Aliaga's credibility argument is right about the cost of waiting but incomplete about the cost of acting. Credibility is not restored by hiking; it is restored by hiking at the right time against the right kind of inflation. If the August and September data confirm that core services inflation is persistent rather than energy-driven, a September hike will look like prevention. If they show the disinflation is already winning, it will look like the Fed tightened into a mirage — and no amount of hawkish resolve can make that credible.
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