Fed officials are convening their monetary policy meeting this week amid a critical debate: with inflation pressures showing no clear signs of easing in the near term, what can the central bank actually do, what should it do, and how will it choose?
The Federal Open Market Committee (FOMC) will announce its decision at 2 a.m. Beijing time on Thursday. The market widely expects the Fed to keep its benchmark rate unchanged, following a 25-basis-point hike in September. However, investors' real focus is on how policymakers will signal the direction of future action, especially what Fed Chair Kevin Warsh will convey.
Deutsche Bank senior U.S. economist Brett Ryan said he will pay close attention to how Warsh describes the future path of monetary policy. Warsh has been reluctant to reveal policy direction in advance, hoping the Fed will reduce its reliance on "forward guidance" and stop frequently previewing policy moves to the market as it has since the 21st century began.
Ryan wrote in a note to clients that Warsh may suggest recent inflation data further validated the judgment made at the September meeting: over time, the Fed may still need to tighten policy further. However, skipping a hike in October would also give officials more time to assess data changes.
Inflation Reheats, Housing and Jobs Markets Under Pressure
Recently released inflation data has not eased the price pressures that intensified earlier this year. The Consumer Price Index (CPI) showed that U.S. headline inflation rose to 3.7% year-on-year in September, mainly driven by surging energy prices. Excluding volatile food and energy prices, core CPI rose 2.6% year-on-year, still above the Fed's 2% inflation target and up 0.3 percentage points from August, reflecting that price pressures have not broadly eased.
Meanwhile, mortgage rates above 7% are placing further strain on the U.S. housing market. The jobs market presents a "low layoffs, low hiring" picture: layoffs are near their lowest level since the late 1960s, but unemployed workers still struggle to find new jobs. Against this backdrop, adjusting monetary policy has become especially complicated.
Pausing rate hikes helps the Fed assess how much its previous tightening measures have affected the economy and financial conditions; but if inflation remains stubbornly high, the Fed may be forced to raise rates further. At that point, the housing market, consumer loans and other rate-sensitive sectors of the economy could come under greater pressure.
Warsh wants to build a Fed with a more flexible policy stance, unwilling to commit prematurely to a future rate path, and instead preferring to let the market judge policy direction based on subsequently released data. The problem is that the Fed must both prove its determination to control inflation and avoid locking in the magnitude and pace of future rate hikes too early.
Economists Warn: Policy Execution Risks Are Rising
Evercore ISI chief economist and head of central bank strategy Krishna Guha believes there is considerable risk of missteps in the current policy environment. Guha said in a report on Monday that Warsh is alert to market risks and in theory should be able to demonstrate calm, steady leadership, but the Fed's policy execution faces major challenges.
He noted that the Fed has not adequately explained how it measures the respective risks to its dual mandate—maintaining low inflation and achieving full employment—nor has it clearly explained how the central bank assesses the current degree of monetary policy tightening. These information gaps make it harder for the market to judge how the Fed will act next.
Although inflation remains persistently hot, the U.S. unemployment rate has generally remained stable. At the same time, financial conditions are also changing. The Chicago Fed's financial conditions index shows that financial conditions have tightened slightly since the September rate hike, with increased stock market volatility being one factor.
Recently, remarks by important officials such as Fed Vice Chair Jefferson and New York Fed President Williams both pointed to the possibility that if inflation pressures persist, the Fed may adopt a pace of raising rates once every other meeting. But how many hikes will ultimately be needed remains unclear.
Guha believes that Warsh's recent speech while attending World Bank and International Monetary Fund events in Bangkok was basically consistent with the mainstream view within the FOMC. This means the Fed may adopt a prudent, methodical tightening pace, with one rate hike per quarter as a possible baseline path, adjusting judgments based on data rather than preemptively ruling out any rate level.
He added that if inflation data continues to disappoint or if economic growth momentum fails to weaken, the Fed could raise rates further.
Market Bets on December Hike, Economists Divided
According to CME Group's FedWatch tool, federal funds rate futures show the market prices about a 10% probability of a Fed rate hike this week, while the probability of a December hike has exceeded 80%. The market also believes there is some possibility of another hike in March 2027; by the end of 2027, the probability of one more Fed rate hike is about 50%.
However, economists remain clearly divided on whether the Fed should continue tightening policy. Citigroup economists believe inflation data may moderate in the coming months, giving the Fed reason to continue holding steady and potentially creating conditions for rate cuts to begin next year. But Citigroup currently still forecasts the Fed will hike in December this year.
Allianz chief economic adviser Mohamed El-Erian expects the Fed will ultimately raise rates again, but he believes doing so would be wrong because higher borrowing costs could hurt vulnerable sectors such as housing and worsen economic inequality. El-Erian said on CNBC on Monday that the market is right to believe the Fed will not act this time, but Warsh must use fairly hawkish language to explain the decision because inflation data has generally exceeded expectations.
He believes that addressing inflation concerns and rising U.S. Treasury yields should rely on "fiscal discipline, not monetary tightening." If the Fed ultimately chooses to tighten policy further, it may not only be the technology sector that takes a hit. El-Erian noted that the technology sector may be relatively less affected, while housing, auto loans, personal consumer loans and other areas could come under greater pressure.
For the Fed, the difficulty of this meeting is not only deciding whether to raise rates, but also how to explain the reasons for holding off while preserving necessary policy space. If Warsh delivers a more hawkish inflation signal, market expectations for a December hike may strengthen further; if he emphasizes patiently observing data, it may ease recent tightening bets. In any case, the inflation trajectory will still determine the policy path.
Treasury Bullish Bets Rise, Warsh Hawkish Signal Could Reverse Yield-Down Trades
If the Fed takes a more hawkish stance at this week's monetary policy meeting, the bullish bets recently accumulated in the U.S. Treasury market could face a sharp reversal. If Warsh delivers hawkish signals on key issues such as inflation, the market may reassess how high the Fed will ultimately raise rates, triggering a painful wave of position unwinding.
Previously, some traders bet on continued safe-haven inflows into U.S. Treasuries, building bullish positions that would profit from falling yields and rising bond prices. Citigroup strategist David Bieber said that before the FOMC meeting, the most obvious change in the market was that investors shifted to tactical long positions in both the U.S. Treasury and European bond markets.
He noted that traders are chasing the bond rally by building bullish positions, even though from an overall structural perspective the market remains net short. CME open interest data shows that over the past week, traders have been reducing short positions in U.S. Treasuries while betting that the previous rebound can continue. Behind this rally are factors including concerns about the sustainability of AI trades and pressure in the French government bond market.
Last Friday, large-scale unwinding occurred in the U.S. Treasury futures market, especially concentrated in contracts related to 10-year Treasuries. A day earlier, the Treasury market had just recorded its best trading day in more than two years, yet large amounts of new risk exposure appeared in 10-year Treasury-related contracts, with trading characteristics consistent with short covering.
JPMorgan's weekly survey also showed that net long positioning in the market has risen to its highest level since early September. Columbia Threadneedle portfolio manager Ed Al-Hussainy said the key factor determining whether the market can sustain current pricing is the Fed's policy guidance. This means that even if no rate hike is delivered at this meeting, Warsh's remarks on subsequent policy could still change market trading logic.
If the Fed clearly signals it is still prepared to tighten policy further, traders may need to reassess bond long positions, and recently established bullish trades would face the risk of forced unwinding. At the same time, options market traders are actively hedging portfolio risks against further yield declines and continued bond price gains. This demand has pushed up the cost of related hedging options, with costs rising last week to their highest level since March.
Many traders are seeking protection by buying call options with different structures, with some strategies betting that 10-year Treasury yields will fall further to around 4.6% in coming weeks. The skew between calls and puts in the options market has also shifted noticeably, with market pricing tilting sharply toward calls. In other words, compared with hedging the risk of rising yields, traders are now willing to pay a higher premium to guard against further yield declines.
This positioning change reflects lingering market expectations for a Treasury rebound, but it also means trades are more vulnerable to policy signal shocks. If Warsh emphasizes that inflation pressures persist and the Fed still needs to raise rates, investors may quickly exit bullish positions, weighing on bond prices and pushing yields back up; conversely, if he does not further reinforce tightening expectations, recent long trades may continue to find support.
This week's Fed meeting is therefore not only about whether short-term rates are adjusted, but may also become a key moment for repositioning in the Treasury market. The real risk is that bullish bets have clearly increased, and once policy guidance deviates from market expectations, the very trading forces that drove bonds higher could also turn into pressure for accelerated unwinding.
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