UBS now expects two hikes in 2026, but inflation data will decide whether the first comes at next week’s meeting.
MARKET INSIDER — The Federal Reserve is approaching its closest interest-rate decision of 2026, with futures markets assigning roughly a 60% probability to a quarter-point increase at the September 15–16 meeting.
UBS now expects the Fed to raise rates by 25 basis points in both September and December, citing a stronger-than-expected labor market, persistent inflation and a more hawkish message from Chair Kevin Warsh.
A September increase is not assured. Producer-price data on Thursday and consumer inflation on Friday could still justify keeping the federal funds rate at 3.5%–3.75%, particularly if underlying price pressures show convincing signs of easing.
Key Highlights
- UBS expects quarter-point Fed rate increases in September and December following stronger employment data.
- Futures markets price approximately a 60% probability of a September hike, while most economists still expect no change.
- August PPI and CPI will determine whether strong growth and higher oil prices outweigh evidence that underlying inflation is cooling.
UBS shifts toward two rate increases
UBS revised its Federal Reserve forecast after the August employment report showed that the U.S. economy added 162,000 jobs, substantially exceeding expectations, while unemployment remained at 4.1%.
The result reduced concerns that higher borrowing costs were causing a rapid deterioration in the labor market.
UBS now expects the Federal Open Market Committee to increase its target rate by 25 basis points in September and deliver another quarter-point move in December. The two increases would lift the range from 3.5%–3.75% to 4%–4.25% by year-end.
The bank cited resilient economic activity, a strong employment market and inflation risks associated with supply constraints.
Fed Chair Kevin Warsh’s Jackson Hole address also contributed to the change. His warning that policymakers still had work to do to return inflation to the 2% target was interpreted as a signal that the Fed is prepared to tighten policy again.
UBS is not alone in reconsidering its forecast. Citigroup, Macquarie and other institutions have adjusted their rate expectations following the employment data and the latest increase in energy prices.
Markets lean toward a hike—but economists disagree
Interest-rate futures imply approximately a 60% probability of a quarter-point increase in September, with the remaining probability assigned mainly to an unchanged decision.
That makes the meeting unusually uncertain. Markets often approach Fed decisions with a much stronger consensus.
The economist community remains more cautious than futures traders. A Reuters poll found that most forecasters expect the Fed to leave rates unchanged in September and throughout the remainder of 2026, although a growing minority now anticipates at least one increase.
The difference reflects uncertainty over how policymakers will balance two competing signals.
Economic growth and employment remain strong enough to tolerate higher rates. At the same time, some measures of underlying inflation have moderated, raising the risk that another increase could tighten policy unnecessarily just as earlier rate moves begin to affect demand.
The Fed’s decision will therefore depend less on whether inflation remains above 2%—it clearly does—and more on whether officials believe it is likely to continue rising or gradually return toward target.
FedWatch probabilities require careful interpretation
CME FedWatch probabilities are sometimes misread as forecasts for separate rate increases at every meeting.
A 70% probability associated with October does not necessarily mean traders expect an October hike in addition to a September move. It generally represents the probability distribution for the policy-rate level after the October meeting.
Similarly, an 86% probability that rates will be higher by December can include several paths: a September increase followed by no action, an increase later in the year or multiple moves.
The current pricing therefore indicates strong confidence that the Fed will tighten at least once before year-end—not certainty that it will increase rates in September, October and December.
Markets are pricing approximately two quarter-point increases by early 2027, but the timing remains dependent on inflation, employment and financial conditions.
Oil above $100 complicates the inflation outlook
The renewed U.S.-Iran conflict has pushed Brent crude above $100 a barrel, raising gasoline, transport and production costs.
An energy-price shock initially affects headline inflation directly. It becomes more problematic if companies pass higher costs into a broad range of goods and services or if workers demand additional wages to preserve purchasing power.
Tariffs provide a second source of pressure. Import duties introduced during earlier trade disputes are still working through supply chains, increasing costs for some manufacturers and retailers.
The combination creates a difficult policy problem.
Central banks cannot produce more oil or eliminate tariffs by raising interest rates. They can, however, prevent an initial price shock from generating persistent inflation through wages, expectations and broader demand.
That is why strong employment matters. A healthy labor market gives the Fed greater freedom to tighten without immediately violating the employment side of its congressional mandate.
However, raising rates in response to supply-driven inflation also carries risk. Higher energy prices already reduce consumers’ disposable income. Additional monetary tightening could amplify the slowdown without materially addressing the source of the shock.
PPI and CPI could decide the meeting
The Bureau of Labor Statistics is scheduled to release the August Producer Price Index at 8:30 a.m. Eastern time on Thursday, followed by the Consumer Price Index at the same time on Friday.
PPI measures price changes received by domestic producers and can provide an early indication of cost pressure entering supply chains.
A stronger-than-expected result would support the case that energy costs, tariffs and supply disruptions are spreading beyond individual categories. Treasury yields and the dollar would probably rise as markets increase the probability of a September move.
A softer PPI report would matter, but CPI is likely to carry greater weight because it measures prices paid by consumers and feeds more directly into inflation expectations.
The most important components will be core services, shelter and categories sensitive to wages and domestic demand. Policymakers may look through part of an energy-driven increase in headline CPI if underlying inflation continues to moderate.
A hot CPI reading would make a September hike substantially more likely. A clearly benign report could shift the market toward a pause.
A hike would not automatically end the equity rally
UBS does not interpret a more hawkish Fed as a reason to abandon risk assets.
The U.S. economy continues to receive support from artificial-intelligence investment, data-center construction, strong corporate earnings and resilient consumer activity.
Those conditions allow company profits to grow even as interest rates remain relatively high.
The danger for equities comes from valuation rather than an immediate collapse in economic activity. Higher bond yields increase the discount rate applied to future earnings, creating the greatest pressure on expensive companies whose valuations depend heavily on profits expected many years ahead.
The S&P 500 declined after Brent moved above $100, with the energy sector outperforming while technology and other rate-sensitive groups weakened. The 10-year Treasury yield approached its highest level since 2023 as investors priced higher inflation and reduced expectations for monetary easing.
A quarter-point Fed increase would therefore be more challenging for highly valued growth stocks, real estate and leveraged companies than for businesses benefiting from strong current cash flow or higher commodity prices.
Higher yields create opportunities in bonds
The recent bond selloff has pushed yields higher, creating potential entry points in high-quality fixed income.
If the Fed begins another tightening cycle, short-term bond yields may remain elevated. But the advantage of short-duration securities over cash can narrow if deposit rates adjust slowly or investors expect policy eventually to reverse.
Intermediate- and longer-duration bonds offer higher income than they did earlier in the year and could appreciate if inflation weakens or economic growth slows.
They also carry more interest-rate risk. A sustained oil shock or multiple Fed increases would push yields higher and prices lower, particularly at longer maturities.
UBS recommends maintaining diversified allocations and using volatility around data releases and policy decisions to rebalance portfolios toward long-term targets rather than attempting to predict every market move.
Implications for Asia and emerging markets
A September Fed increase would probably support the dollar and tighten financial conditions across emerging markets.
Asian central banks could face pressure to maintain higher domestic rates to protect their currencies and limit imported inflation. Economies dependent on oil imports would confront the combined burden of expensive energy and a stronger dollar.
Capital flows would also become more selective. Countries with strong external balances, credible monetary policy and healthy growth could continue attracting investment, while markets with large dollar debts or current-account deficits would face greater pressure.
Technology exporters may remain supported by AI-related demand, but higher U.S. yields could compress valuations across regional equity markets.
The global effect may be amplified because the European Central Bank and Bank of Japan are also considering rate increases. Simultaneous tightening would reduce global liquidity even if policy divergence between individual economies remains limited.
What investors should watch
The first signal is whether PPI and CPI show price pressure broadening beyond energy. Persistent core inflation would strengthen the case for two UBS-style increases this year.
The second is the Fed’s policy statement and Warsh’s press conference. Markets will need to determine whether a September move is a one-time adjustment or the beginning of a longer tightening sequence.
The updated “dot plot” will show how many officials expect additional rate increases and where they see policy heading in 2027.
Finally, investors should watch the interaction between oil and Treasury yields. If crude remains above $100 while long-term yields continue rising, financial conditions could tighten even before the Fed acts.
A September hike is now slightly more likely than a pause according to futures markets, but it remains far from settled. Inflation data—not the strong jobs report alone—will determine whether the Fed concludes that waiting is prudent or that delay would allow price pressures to become entrenched.
