When the Federal Reserve, under Chair Kevin Warsh, implemented its first interest rate increase since 2023 on September 16th, the prevailing market wisdom suggested this would be the first step in a longer sequence. This view was echoed by several former officials, including ex-St. Louis Fed President Jim Bullard and former Vice Chair Richard Clarida. Reflecting this sentiment, swap traders are currently pricing in roughly three additional rate hikes by the end of 2027.

There is a solid financial rationale for this expectation, as a single 25-basis-point move rarely has a significant impact on the broader bond market, financial conditions, or the economy. However, there is a notable exception to this rule: the lone rate hike implemented by then-Chair Alan Greenspan in March 1997, which occurred mid-cycle. This historical parallel bears a striking resemblance to today's situation and suggests that some economies benefit from even the most subtle policy adjustments.

The central bank's latest policy survey indicates that the median participant anticipates one more rate increase by the end of 2026. The survey, which included 18 regional bank presidents and Board of Governors members (but not the Chair), also revealed that a vast majority acknowledge heightened uncertainty surrounding their inflation forecasts. When pressed on future actions during the post-decision press conference, Chair Warsh was non-committal, stating, "I'm not going to pre-empt any decisions we might make in the future."

Let's examine the base case. In the Fed's modern history, which began in 1994 with the public announcement of policy decisions, nearly all rate-hiking cycles were initiated from very low levels following a recession, leaving policymakers substantial room to maneuver. The only exceptions were 1997 and today, where rates have already risen to 3.75%-4%. Like the venerated "maestro" Greenspan, the new Fed Chair is navigating a phase of policy fine-tuning.

If one looks past the volatility in oil prices and other temporary factors, the underlying inflation rate appears to be around 2.3%–2.7%. While this is above the 2% target, it is far from a runaway scenario. The challenge for Chair Warsh is that inflation has now exceeded the target for five and a half consecutive years with no signs of cooling, potentially necessitating some pressure to resume the disinflationary trend seen from 2022 through 2024. Greenspan's policy calibration task was similarly complex, with strong economic growth and sharply falling unemployment. The concern then was a potential overheating economy that might ignite future inflation. Despite inflation being contained at the time, the Fed's internal models projected a modest rise in core consumer prices of around 3.2% in 1998, driven by tight labor markets.

Another point of convergence is the technological shock. Chair Warsh must contend with the AI-driven revolution, which could boost productivity and growth, forcing a rethink of established assumptions about how rates function. Greenspan, during his tenure, was dealing with the onset of the internet revolution. When the economic landscape shifts, policymakers lose clarity on what constitutes a "restrictive," "neutral," or "accommodative" stance. This uncertainty is evident in their recent projections, which have raised the estimate of the neutral rate to 3.2%, a ten-year high. The Fed's own surveys suggest policymakers are in no rush to lower rates from their peak back to neutral. The unpredictable impact of productivity-driven growth on rates could either suppress inflation or increase borrowing demand.

The situation in 1997 was similar, with the rate-setting committee openly deliberating the potential impact of a rising neutral rate. According to the meeting minutes, Richmond Fed President J. Alfred Broaddus told Greenspan, "If monetary policy fails to recognize the change in equilibrium and does not raise nominal rates, then, in effect, even if we maintain the same nominal rate, we would be easing policy." This sentiment could just as easily apply to September 2026.

Finally, the Fed's September 16th action solidifies its credibility. Chair Warsh was appointed by President Donald Trump, who has been one of the most interventionist presidents in modern history. Questions about Warsh's independence were rife from the start, regardless of their validity. As rate hikes became the consensus expectation, Trump publicly called for rate cuts in recent weeks. Failing to act would have made Warsh appear to be yielding to presidential pressure ahead of the November midterm elections. The Fed under Greenspan was also well aware of the importance of its credibility, especially since the FOMC had not resorted to rate hikes since the 1994-1995 tightening cycle. Tom Melzer, then-president of the St. Louis Fed, articulated this at the time, saying, "My reading of the economy supports the conclusion that we risk losing the hard-won credibility that comes from our commitment to controlling inflation."

Greenspan is widely praised, including by Warsh himself, for his foresight in predicting inflation would remain contained and for his reluctance to stifle a strong economy. But he also benefited from some luck, including falling global energy prices, a strong dollar that made imports cheaper, and the institutional reputation further enhanced by his predecessor, Paul Volcker. It is also worth noting that Greenspan and his colleagues did not initially intend for the 1997 hike to be a "one-off." It was only in subsequent meetings that he developed his theory on productivity suppressing inflation. By 1998, the Russian debt default and the collapse of the hedge fund Long-Term Capital Management forced the Fed back into an easing mode.

So, what is the point of this small adjustment? By acting, Chair Warsh has defended the Fed's credibility and bought himself a low-cost option. If the economy eventually requires more rate increases, he can still implement them. However, he may already be close to his final destination. Should he enjoy the same luck as Greenspan, he may have already arrived.