Fed Expected to Hold Rates Steady This Week! Market Focus Shifts to a December Rate Hike as Warsh Faces a "Major Communications Test"

If the Fed decides to keep rates unchanged this week, Fed Chair Warsh will once again face a familiar challenge: he must convince investors that the Fed is committed to curbing inflation while explaining why officials chose not to raise rates. This is exactly the situation Warsh encountered in July. At that time, investors took the Fed's decision to keep rates unchanged in stride, but were dissatisfied with Warsh's reluctance to signal that borrowing costs might need to be raised further. After the September rate hike, the Fed is expected to keep rates unchanged again this week. That shifts the market's focus to December. The market widely believes there is a high probability that the Fed will raise rates for the second time this year at that point. Stephen Stanley, chief economist at Santander US Capital Markets, said: "I don't expect rates to change, but I do think they will raise rates again in December. The communication challenge at this meeting is that Warsh needs to explain why they did not raise rates in October. After laying out that rationale, he must also explain why a December hike remains a realistic option." Warsh may get some help from his colleagues. One or more Fed officials could lead the case for a December hike by dissenting against the decision to keep rates unchanged. But none of those officials can speak on Wednesday, which creates a challenge Warsh may not want to face. Since joining the Fed in May, he has refused to provide the market with guidance on the future path of rates. Warsh believes that forward guidance, despite limited support from other policymakers, is often misinterpreted as a Fed commitment to a specific future decision and should therefore be used only during economic crises. In such cases, a genuine commitment can significantly enhance the effect of Fed policy actions. But he says that when officials are making relatively small policy adjustments aimed at broadly keeping the economy in balance, providing forward guidance can constrain the Fed's flexibility. As a result, apart from reiterating the Fed's firm commitment to bringing inflation back to its 2% target, Warsh has disclosed almost nothing about future rate decisions. Instead, he advises investors to focus on economic data when predicting the path of rates. That approach has already caused trouble. At the press conference after the Fed's July decision to keep rates unchanged, Warsh's remarks were too brief and sent markets into turmoil. At the time, investors were eager for some assurance that the Fed would act if price pressures intensified. Warsh then adjusted his communication strategy in an August speech, revealing more of his policy thinking and taking a more hawkish stance on inflation. At the subsequent September meeting, he and his colleagues reinforced that stance with a rate hike and used quarterly rate projections to signal that the Fed would likely raise rates one more time at its two remaining meetings this year. In the weeks that followed, however, the inflation situation worsened further. Elevated oil prices continued to pass through the economy, and a wide spread between crude and refined products amplified the effect. That pushed both consumer prices and wholesale prices higher in September. At the same time, strong demand from artificial intelligence (AI) infrastructure investment continued to drive up prices for materials, components and electricity, which in turn raised prices for consumer electronics, personal computers and electricity. Aditya Bhave, head of US economics research at Bank of America, said: "The rationale they gave for raising rates in September was that inflation was becoming concerning. Since then, overall, inflation has gotten worse." He expects the Fed to surprise with a rate hike next week. In response, investors followed Warsh's advice, scrutinized economic data and began pricing in an October hike, until key officials intervened and changed market expectations. In speeches on September 29 and October 1, New York Fed President John Williams and Fed Vice Chair Philip Jefferson respectively said the Fed could afford to be patient and did not need to rush to consider when to raise rates next. Another closely watched policymaker, Fed Governor Christopher Waller, conveyed a similar message. The signal seemed unusually clear. Investors concluded that the economic data had been released and forward guidance was backat least for October. Market-implied odds of a rate hike therefore fell from above 70% to below 30%. On October 16, when Warsh spoke at the International Monetary Fund (IMF) annual meetings in Bangkok, he had an opportunity to realign market expectations with recent inflation data, but he did not do so. He said global conditions since the September meeting had been "broadly in line with our expectations." On Wednesday, when Warsh steps up to the microphone, he will be under pressure not only to explain why rates are being held steady, but also to clear up the confusion created by the messy policy communication. Election shadow Meanwhile, the political backdrop lingers. US President Trump, while blaming Warsh's colleagues, still sharply criticized the Fed's September rate hike. If the Fed raises rates again this week, just days before key midterm elections, it could provoke a fierce reaction from the White House. As successive Fed chairs have always done, Warsh will almost certainly deny that the election has any bearing on rate decisions. Still, he can offer other reasonable explanations. Like Williams and Jefferson, Warsh can emphasize that after the September hike, the Fed still has time to analyze economic data due before the December meeting. By December, officials will have the September inflation gauge they value most, multiple October inflation readings, October and November employment data, and the first estimate of third-quarter gross domestic product (GDP). Warsh may also restate his view that rising long-term US Treasury yields are helping the Fed achieve its policy goals. Until a surge in buying last week, the 10-year US Treasury yield had held above 5% for a month. That pushed up financing costs for everything from housing and autos to credit card debt. However, if Warsh is willing to defend the decision to keep rates unchanged, he must tread carefully and avoid appearing overly optimistic about inflation, so as not to trigger another bout of sharp market volatility. Kathy Bostjancic, chief economist at Nationwide, said: "If they do not tighten monetary policy, there is indeed a risk that the effects of higher energy prices could spread further. Standing pat could unsettle bond investors and cause long-term rates to spiral out of control."