UBS Global Wealth Management has revised its monetary policy outlook, now expecting the Federal Reserve to deliver two additional quarter-point rate increases—one in December and another in early 2027—following September's stronger-than-expected inflation data. The bank's updated forecast points to a longer tightening cycle than previously anticipated, followed by an extended pause.
The September consumer price index (CPI) rose 0.6% month-over-month, pushing the annual inflation rate to 3.7%, above the 3.6% forecast from economists surveyed by Dow Jones. Rising gasoline prices accounted for more than half of the monthly increase, but core goods and core services also accelerated, a development UBS economist Andrew Dubinsky described as a "hawkish surprise."
"The September report was a hawkish surprise: Much of the headline strength reflected energy, but the simultaneous acceleration in core goods and core services should keep the Fed focused on inflation risks and reinforce higher-for-longer policy expectations," Dubinsky wrote in a research note.
The Fed raised its benchmark rate by 25 basis points last month to a range of 3.75%-4.00%, its first increase since 2023. UBS now expects another quarter-point hike in December, followed by a further 25 basis point increase in March 2027. The bank said the extended tightening cycle is designed to keep inflation expectations anchored while inflation remains near 3% amid overlapping economic shocks.
"The longer tightening cycle is designed to ensure inflation expectations stay anchored while inflation remains near 3% due to overlapping shocks," the bank said.
Interest-rate futures have responded to the inflation report by raising the implied probability of further Fed action. According to CME FedWatch data, markets were pricing in a roughly 27% probability of a rate increase at the Fed's October meeting, up from 21.6% before the CPI release. The probability of a December rate increase stood around 90%, suggesting investors see another move before year-end as increasingly likely.
The hotter-than-expected inflation reading complicates the Fed's balancing act between controlling price pressures and avoiding an economic slowdown. While energy prices drove much of the headline increase, the acceleration in core inflation suggests underlying price pressures remain persistent.
UBS's forecast of a March 2027 hike implies a longer period of restrictive policy than markets had previously priced. The bank expects policymakers to pause after the March move to assess the cumulative impact of the tightening cycle on economic activity.
The September CPI report has also weighed on equity markets, with investors recalibrating expectations for monetary policy. The Dow Jones Industrial Average rose 198 points as bank earnings and inflation data loomed, while the Nasdaq dropped 1.24% as AI stocks slid and oil surge stoked inflation fears.
For investors, the key takeaway is that the Fed's path to lower rates may be longer than hoped. With inflation running above target and core pressures accelerating, the central bank is likely to maintain a hawkish stance well into next year.
This article is for informational purposes only and does not constitute financial advice.
