Beware of Fed Misjudging Inflation: September Rate Hike Could Be an Unnecessary Policy Mistake

FX678 News, September 8—— As of last weekend, the probability given by the federal funds rate futures market indicated that the likelihood of the Federal Reserve making a policy mistake and raising rates in mid-September was close to 60%. We believe the Fed may not necessarily make this mistake, but if a rate hike does occur, it could trigger deeper corrections in the gold, stock, and foreign exchange markets: gold prices and the S&P 500 Index could decline, while the U.S. Dollar Index could strengthen. The logic is: rate hikes boost the dollar and raise real interest rates, which often suppress gold and overvalued stocks priced in dollars, while promoting capital to flow back to dollar assets.

Federal Reserve rate hikes cannot make more ships pass through the Strait of Hormuz, nor can they make refineries produce more diesel, or enable farmers to grow more corn. The transmission mechanism of monetary policy has natural limitations—raising or lowering interest rates changes the cost of funds and the credit environment, but cannot directly restore a disrupted physical supply. More broadly: when price increases are driven by supply constraints rather than overheated demand, central bank rate hikes are not a reasonable response, and may instead deviate from the core issue by "treating a headache by addressing the foot."

In other words, gaps on the supply side must be bridged by physical measures such as increasing capacity, smoothing logistics, and repairing infrastructure. Monetary policy cannot fill supply gaps, and may, by curbing investment willingness, make these gaps even harder to close. Nevertheless, many commentators advocate for the Fed to hike rates in September, reasoning that "inflation is far above the Fed's target!"—as if any elevated price reading should immediately trigger tightening tools, without questioning the root causes behind those readings.

Unfortunately, most members of the Federal Open Market Committee (FOMC) similarly ignore the realities of the economy, focusing single-mindedly on highly watched inflation figures and employment reports with accuracy so low as to be virtually worthless as references. In other words, policymakers are more inclined to mechanically respond to statistical data that are "visible and easy to cite," rather than base decisions on judgments about the real workings of the economy; meanwhile, distortions in the employment data themselves actually undermine the premise of the "data-driven" narrative. In addition, the pressure tactics released by Trump toward the Fed also have a negative effect. The reason is: to maintain the appearance of institutional independence, even if there were FOMC members inclined to cut rates (currently there are none), presidential pressure might force them to adopt the opposite stance. Herein lies a subtle reverse mechanism: the more external pressure, the more a "steadfast" posture is needed to prove independence—ironically causing rate cut options that deserved debate to be ruled out prematurely.

This leads to the following situation: regardless of the real causes behind rising inflation or the optimal solution, the default logic in financial markets is—if economic data suggest further price increases or strong economic performance, the chance of a Fed rate hike rises. This means that market pricing follows a highly simplified "data—policy" linear mapping, almost without concern for whether the causal chain behind the data supports tightening.

Affected by the latest news, the federal funds rate futures market's probability for a rate hike at the September 16 FOMC meeting was 70% last Tuesday, dropped to 50% by Thursday, and climbed back to 59% on Friday. The gold market is most sensitive to these rate hike probability swings. Such drastic volatility itself is a direct manifestation of uncertainty: switching directions twice within a week indicates that the market lacks a stable judgment about the Fed's true intentions and the path of future data.

In other words, as of last weekend, the probability given by the federal funds rate futures market indicated that the likelihood of the Federal Reserve making a policy mistake and raising rates in mid-September was close to 60%. We believe the Fed may not necessarily make this mistake, but if a rate hike does occur, it could trigger deeper corrections in the gold, stock, and foreign exchange markets: gold prices and the S&P 500 Index could decline, while the U.S. Dollar Index could strengthen. The logic is: rate hikes boost the dollar and raise real interest rates, which often suppress gold and overvalued stocks priced in dollars, while promoting capital to flow back to dollar assets.