Fed Holds Rates Steady; Warsh Signals Caution as Market Still Bets on a December Hike

The Federal Reserve announced on Wednesday that it would keep its benchmark interest rate unchanged, maintaining the federal funds rate target range at 3.75% to 4%, in line with widespread market expectations. This marks a pause after the Fed implemented its first rate hike in three years in September. Despite persistently elevated inflation and strong U.S. economic performance, Fed Chair Kevin Warsh did not explicitly signal another rate hike in December, instead emphasizing that policymakers need more economic data to determine the next step. Meanwhile, Warsh announced that the Fed will adjust its monetary policy meeting schedule starting next year, remarks that the market interpreted as a dovish signal, pushing short-term Treasury yields and the dollar lower. The rate decision was approved by a 10-2 vote. Fed Governor Lisa Cook and Cleveland Fed President Beth Hammack both advocated for an immediate 25-basis-point rate hike to address persistent inflationary pressures. In its policy statement, the Fed said more economic data will be released in the coming weeks, and that this information will help the Federal Open Market Committee (FOMC) determine the appropriate policy stance and ensure inflation returns to its 2% longer-run goal in a timely manner. The statement also emphasized the Fed's commitment to restoring price stability. Inflation Remains the Policy Focus; Warsh Stresses Readiness to Act Although the Fed chose to pause rate hikes this time, the latest policy statement upgraded its assessment of the U.S. economy. The Fed revised its description of the pace of economic activity from "moderate" in the September statement to "strong," while noting that domestic spending has shown resilience, the unemployment rate has changed little, but inflation remains elevated. At the subsequent press conference, Warsh said that although he does not believe the U.S. economy has begun to overheat, strong consumer spending and solid business investment indicate that economic activity has outperformed previous expectations. Therefore, discussions at this monetary policy meeting focused primarily on inflation. Warsh said: "Our responsibility is to bring inflation down. That is why the FOMC's discussions over the past two days have focused mainly on our price stability mandate." He also emphasized that the Fed has made clear it will act as economic conditions require and has already demonstrated its willingness to act. Recently released economic data further highlighted inflationary pressures. The U.S. consumer price index (CPI) rose 3.7% year-over-year in September, above market expectations and close to the three-year high set in May this year, while the month-over-month increase reached its highest level in five months. Rising energy prices were one of the important factors driving the acceleration in inflation. Affected by the Iran war, international oil prices have remained elevated and are gradually feeding through to prices of other goods and services. At the same time, the U.S. government's tariff policies and data center construction driven by the artificial intelligence (AI) investment boom have also put upward pressure on prices of certain goods and services. Warsh noted that energy and related prices have risen again in recent weeks, and the Fed must ensure that relative price changes in some sectors do not evolve into broad-based inflation across the entire economy. It is worth noting that the Fed has failed to keep inflation stably at its 2% longer-run target for more than five consecutive years. December Rate Hike Expectations Persist, but Bets on Further Tightening Have Cooled Although Warsh did not provide clear guidance on the December rate decision, financial markets still widely expect the Fed to raise rates again before the end of the year. According to interest rate futures market pricing, traders expect the probability of a 25-basis-point rate hike in December to exceed 90%. However, as Warsh emphasized at the press conference that financial conditions have already tightened somewhat, investors lowered their expectations for further rate hikes in 2027. Warsh said market participants are becoming more prudent in capital allocation, and overall financial conditions have tightened compared with earlier. But he also noted that financial conditions cannot yet be characterized as truly restrictive. These remarks prompted the market to reassess the Fed's subsequent policy path. Although traders still bet on a December rate hike, interest rate futures markets no longer fully reflect expectations of three more rate hikes in this tightening cycle. In fact, market expectations for an October rate hike underwent notable changes over the past few weeks. After the Fed's September rate hike, interest rate futures at one point showed a probability of more than 70% for another rate hike in October. But subsequently, New York Fed President John Williams and Fed Vice Chair Philip Jefferson both said that the September rate hike gave policymakers more time to assess the economic situation, causing market expectations to cool rapidly. On October 16, Warsh further stated that since the September meeting, the global economic situation has largely been in line with Fed expectations. The market viewed this remark as a signal that the Fed is inclined to keep rates unchanged. As of before the Wednesday rate decision was announced, the market-implied probability of an October rate hike had fallen below 10%. Fed to Adjust Meeting Schedule; Market Interprets as Dovish Signal In addition to the rate decision, Warsh also announced that the Fed will gradually adjust its monetary policy meeting schedule starting in 2027. Under the new plan, the Fed will still hold eight FOMC meetings per year, but some of those meetings will no longer involve rate decisions and will instead be dedicated to discussing broader monetary policy strategy. Specifically, of the eight meetings in 2027, seven will involve rate decisions, and one will be used to discuss longer-term monetary policy strategy, without voting on the benchmark rate or issuing a rate decision statement. By 2028, two of the eight meetings will be used for broader policy discussions rather than deciding the level of interest rates. Warsh said the Fed believes holding eight meetings per year remains appropriate, but formulating the right monetary policy requires not only regular assessment of short-term economic changes but also sufficient room for discussion of longer-term, more strategic issues. After becoming Fed Chair in May this year, Warsh proposed in July the idea of reducing the eight annual policy meetings to six, arguing that lower meeting frequency would allow more economic data to accumulate between decisions. The adjustment plan announced this time retains the eight-meeting-per-year arrangement but reduces the number of meetings at which rate decisions are actually made. Markets reacted quickly to the change. After Warsh announced the adjustment to the meeting schedule, the yield on the two-year U.S. Treasury note, which is sensitive to the monetary policy outlook, fell as much as 4 basis points to 4.7%. Earlier, after the Fed announced it would keep rates unchanged, the two-year Treasury yield had risen as much as 5 basis points. The dollar also gave up earlier gains and turned lower. Steve Englander, global head of G10 FX research at Standard Chartered, said the market began to show notable fluctuations when Warsh discussed the meeting schedule adjustment, with investors interpreting the change as a dovish signal. However, some analysts noted that the new meeting system could also have technical implications for the pricing of interest rate futures and related financial products. Gennadiy Goldberg, head of U.S. rates strategy at TD Securities, said that because the market currently has financial contracts trading on all scheduled FOMC meeting dates, the Fed may need to inform the market sufficiently in advance of the specific arrangements to avoid pricing problems. Goldman Sachs Asset Management Expects Rate Hikes to Resume in December; Energy Prices Remain Key Risk Although the Fed held steady this time, some Wall Street institutions believe that rising inflationary pressures mean the rate hike cycle is not over. Kay Haigh, global head and chief investment officer of fixed income and liquidity solutions at Goldman Sachs Asset Management, said the acceleration in inflation shown by recent economic data indicates that price risks remain. She expects the Fed to resume rate hikes in December. Haigh noted that if energy prices rise further or subsequent economic data continue to show strength, the Fed may need to take more tightening measures next year. Gregory Faranello, head of macro strategy at South Street Securities Holdings, likewise said that as long as inflation remains above the official 2% target, the Fed will continue to face pressure to control prices. Next, the market will focus on the U.S. September personal consumption expenditures (PCE) price index to be released on Thursday. This is an important gauge of inflation for the Fed, and the data could further influence market judgments on the December rate decision. In addition, U.S. third-quarter economic growth data will also be released on Thursday. Economists expect U.S. gross domestic product (GDP) to have grown at an annualized rate of about 3.2% in the third quarter, indicating that economic activity remains strong. Strong consumer spending and large-scale investment in AI are considered important factors supporting U.S. economic growth. Midterm Elections Approach; Fed Independence Continues to Draw Attention This rate decision comes just six days before the U.S. midterm elections on November 3. Persistently high living costs and inflation have become important economic issues during the election period. At the same time, the Fed's policy independence continues to draw attention. The Trump administration previously sought to remove Fed Governor Cook from office, but the move was blocked by the courts. Cook is currently still defending herself against allegations raised by the Trump administration and denies claims of mortgage fraud. It is worth noting that Cook voted in favor of a 25-basis-point rate hike this time, in sharp contrast to the Trump administration's earlier calls for lower interest rates. Former Cleveland Fed President Loretta Mester said that based on her experience participating in FOMC meetings during her tenure, the Fed does not take political factors into account when discussing monetary policy. Overall, the Fed's rate pause in October does not mean the current monetary policy tightening cycle has ended. Persistently high inflation, strong economic activity and rising energy prices still provide reasons for further rate hikes in the future. However, Warsh's assessment that financial conditions have tightened, along with the Fed's upcoming adjustment to its meeting schedule, has also led the market to reassess the pace and magnitude of future policy tightening. Before the December meeting, U.S. inflation, employment and economic growth data will be key factors determining the Fed's next move.