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Since taking office, Federal Reserve Chair Kevin Warsh has consistently been unwilling to provide any guidance on the potential path of benchmark interest rates. However, persistently high inflation, oil prices above $100 per barrel, and his own emphasis on maintaining price stability and monitoring financial markets' pricing signals seem to have removed the suspense surrounding the upcoming rate path in advance…

The Federal Reserve will announce its rate decision at 2:00 a.m. Beijing time on Thursday. Market traders are currently broadly betting that Fed policymakers will raise the federal funds target range by 25 basis points to 3.75%-4.00%. Meanwhile, the Fed may still raise rates further in the future.

In response, Jay Barry, global head of interest-rate strategy at JPMorgan, outlined five possible scenarios for the Fed this week in a latest research report…

Scenario ①: No rate hike

The JPMorgan team believes the probability of this occurring is extremely low, because standing pat would damage the Fed's credibility and make the hawkish reaction at the Fed's July meeting appear hollow. If this occurs, JPMorgan believes the 1y1y OIS (the forward overnight index swap rate for a one-year period beginning one year from now, serving as a reflection of market expectations for the Fed's ultimate policy path) could fall by 25 basis points; given the sensitivity of Treasury yields to policy expectations in recent months, this could mean a 20-basis-point decline in the 2-year Treasury yield.

Scenario ②: Raise rates, but provide no forward guidance

Under this scenario, the FOMC announces a 25-basis-point rate hike to address inflation above target, but Warsh still provides no forward guidance. This ambiguity could lead to a modest decline in short-term interest rates.

Scenario ③: Raise rates and signal an exit from the 2025 easing policy

JPMorgan believes that, given Fed Chair Warsh's view that the labor market is already at full employment, he may imply that the 75 basis points of “risk-management” rate cuts in 2025 were unnecessary. Against this backdrop, short-term rates could temporarily move toward pricing in a total of 75 basis points in rate hikes.

Scenario ④: Raise rates while lifting R* (the neutral rate)

Under this scenario, Fed Chair Warsh would acknowledge that current policy is not sufficiently restrictive, while also acknowledging that large-scale investment in artificial intelligence could boost productivity, resulting in higher trend growth and a higher neutral policy rate.

The market appears to have priced in this outcome to some extent: the 1y1y OIS rate has returned to near its cycle high, while long-end forward rate expectations have exceeded their 2023 highs, indicating that the market believes rates will remain higher for longer. This is likely due to structural changes in the U.S. economy. Given that perceptions of the neutral rate tend to evolve slowly over time, JPMorgan believes short-term rates would not fluctuate significantly under this scenario, while long-end forward rates would still have room to rise further.

Scenario ⑤: Raise rates and vow to crush inflation

Borrowing an analogy from JPMorgan Managing Director and Chief Economist Bruce Kasman (who referenced the New and Old Testaments of the Bible), this would mean the Fed transforming from a tolerant committee into a more punitive, old-style central bank—committed to quickly bringing inflation down to target and allowing the market to price in a higher terminal rate. However, JPMorgan believes that against this backdrop, long-end forward OIS rates could fall, as the market would interpret it as the Fed being willing to sacrifice economic growth and the labor market to restore price stability.

Overall, compared with previous forward-looking forecasts, Jay and his team were unwilling to assign specific probabilities to the outcomes of these scenarios. They did, however, point out that “no rate hike” and “crush inflation” appear, in their view, less likely than the other three outcomes, which overall may also help the 2-year Treasury yield hold firm.
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