Shenwan Hongyuan Group: With sticky inflation in Q4, the probability of a Fed rate hike in December remains high

Shenwan Hongyuan Group released a research report maintaining its baseline assumption of a 25bp Fed rate hike in December. On one hand, US inflation in Q4 may enter a "grinding top" phase, driven mainly by base effects and the high oil price backdrop; Warsh also acknowledged that energy prices have risen again in recent weeks. On the other hand, the "wait-and-see faction" within the committee is not dovish; if inflation data come in strong, employment remains stable, and market pricing assigns a high probability to a hike, a December Fed rate hike landing may still be the baseline assumption. Shenwan Hongyuan Group's main views are as follows: On October 28 local time, the Fed released the decision from its October regular meeting. Key points: 1) Rates were held unchanged, but Cook and Hammack voted against; 2) Starting in 2027, the FOMC meeting schedule will be adjustedthe total of 8 meetings per year remains unchanged, but the number of policy meetings will decrease; 3) Warsh stated that tighter financial conditions are in line with expectations, and holding steady in October was intended to gather more information. I. Rates held unchanged at the October meeting; market rate hike expectations cooled slightly The October FOMC meeting held rates unchanged, but Cook and Hammack voted against, favoring a 25bp hike. On fundamentals, the October meeting statement emphasized strong economic activity, with more optimistic wording than September, but its assessment of productivity, investment, and inflation was unchanged; on the basis for monetary policy, the statement shifted from emphasizing the role of rate hikes to waiting for more information to assess the appropriate policy stance; on the vote, two dissents appeared at this meeting, indicating that tightening demands persist within the Fed and the hiking process is not yet over. Under the Fed's "wait-and-see" tone, market rate hike expectations cooled slightly. After the Fed statement was released at 2:00 Beijing time on October 29, asset prices showed little immediate change, but after the press conference began at 2:30, 2Y US Treasury yields and the dollar index fell while gold prices rose. During the press conference, Warsh stated that tighter financial conditions are in line with expectations and that more information will help judge the appropriate policy stance, which the market interpreted as a dovish signal. Notably, 10Y US Treasury yields moved in a choppy range, diverging from the 2Y yield trend. II. FOMC meeting mechanism reform is the biggest marginal change this time In his opening remarks at the press conference, Warsh announced that the FOMC meeting schedule will be adjusted starting in 2027. The Fed will still hold 8 meetings per year, but in 2027 one meeting will focus on long-term policy strategy, with no voting and no policy statement, increasing to 2 such meetings in 2028. In other words, traditional "policy" meetings will be reduced to 7 in 2027 and 6 in 2028. Warsh believes the US economy is strong, AI investment is spreading, employment is solid, and strong growth does not necessarily push up inflation. Warsh noted that Q3 growth accelerated further, high-tech investment is spreading to other sectors, and employment performance is good. Real-time forecast data show Q3 US growth may exceed 3%; as early as Q2, US equipment investment data already showed AI investment spreading to traditional industries; on employment, with weak labor supply, the US unemployment rate and nonfarm payroll gains both remain solid. Tighter financial conditions are in line with expectations, and the Fed can remain patient. Regarding "why no hike at this meeting," Warsh offered two lines of reasoning: first, decisions are not based on a single date or data point; second, inflation compensation and inflation expectations are moving in the right direction. Regarding "whether there will be a hike in December," Warsh also made two points clear: he does not support forward guidance in normal times, and he will not confirm whether there will be a December hike nor update forecasts on behalf of other membersbut Warsh did not deny that a December hike is the "consensus" of most members. III. With sticky Q4 inflation, the probability of a December hike remains high We maintain our baseline assumption of a 25bp Fed rate hike in December. On one hand, US inflation in Q4 may enter a "grinding top" phase, driven mainly by base effects and the high oil price backdrop; Warsh also acknowledged that energy prices have risen again in recent weeks. On the other hand, apart from Cook and Hammack, who dissented this time, the "wait-and-see faction" within the committee is not dovish; if inflation data come in strong, employment remains stable, and market pricing assigns a high probability to a hike, a December Fed rate hike landing may still be the baseline assumption. Currently, Fed tightening remains in its "first half," i.e., "compensatory" rate hikes. The inflation problem now is that underlying inflation is not converging fast enough, so rate hikes are "compensatory," with the goal of returning rates to neutral, featuring follow-the-data and discretionary characteristics; whether the "second half" of "genuine" tightening begins depends on future risks of an underlying inflation "reversal," such as AI capital expenditure and wages. With medium- to long-term inflation anchored, Fed rate hikes in the "second half" represent a medium-term "tail risk." Risk warnings: the central crude oil price rises more than expected; Warsh's policy stance is "hawkish"; US economic slowdown exceeds expectations.