The Fed is widely expected to keep rates unchanged this week, yet a pause does not mean the tightening cycle has ended. The policy statement, dissenting votes from officials and Kevin Warsh's remarks on inflation risks could still reshape market expectations for a December hike and the future policy path.
The Fed will release its policy statement at 2 a.m. Beijing time on Thursday, and Chair Kevin Warsh is scheduled to hold a press conference 30 minutes later. Markets broadly expect the Fed to keep rates unchanged, but that does not mean the rate hike cycle is over. September inflation data remained hot, economic activity is still resilient, and with the Nov. 3 midterm elections approaching, Warsh must not only explain why the Fed is pausing tightening, but also address market expectations for another hike in December.
According to CME Group's FedWatch tool, investors see a 90% probability that the Fed will keep the benchmark rate at 3.75% to 4.00% at its Oct. 27-28 meeting. After the September hike, U.S. Treasury yields surged sharply, pushing up household and business borrowing costs, giving the Fed a reason to hold off. But a pause does not mean inflation risks have faded.
Markets expect Thursday's personal consumption expenditures price index data to show inflation continued to accelerate in September, while third-quarter growth may also stay strong, supported by consumer spending and AI-related business investment. Economists expect the PCE inflation rate the Fed watches closely to rise to 3.6% year over year in September from 3.4% in August. The Middle East conflict has pushed up gasoline prices, one reason for faster inflation, but price pressures have also spread to airfares, rents and computers, complicating the task of returning inflation to the Fed's 2% target.
Meanwhile, the U.S. labor market has not shown obvious deterioration. The unemployment rate stood at 4.2% in September, and weekly initial jobless claims remain unusually low. A Reuters survey shows economists expect third-quarter U.S. GDP growth of 3.2% year over year, up from 2.2% in the prior quarter, before slowing to 2.2% in the fourth quarter. AI infrastructure investment and consumer spending have supported the economy.
However, UBS U.S. economist Abigail Watt said the current resilience largely comes from investment driven by AI technology buildout and consumption supported by higher-income groups benefiting from stock market gains. That means strong headline data does not necessarily mean all households and businesses can withstand higher rates. Continued hikes raise housing, auto and corporate financing costs, and may especially burden consumers already facing high energy prices. The Fed still faces a difficult trade-off between curbing inflation and avoiding excessive pressure on the economy.
Bond market tightening gives the Fed time to watch
One important basis for the Fed's pause is that the earlier rise in U.S. Treasury yields had already significantly raised financing costs. After the September hike, the 10-year Treasury yield rose to near a 25-year high, adding further restraint on economic activity. Higher Treasury yields push up corporate financing costs and household borrowing rates, partly doing the Fed's tightening work. New York Fed President John Williams and Fed Vice Chair Philip Jefferson previously said policymakers can wait for more economic data before deciding whether to hike further.
But that logic has shifted recently. Late last week, U.S. Treasury yields fell after a stock selloff triggered by concerns over the sustainability of AI demand. If financial conditions ease as a result, market expectations for an extended Fed pause could be challenged. Morgan Stanley chief U.S. economist Michael Gapen expects the Fed to hold rates steady this week but still signal possible future hikes. He believes the committee may stress the need for more time to judge the underlying inflation trend before deciding its next move.
December hike expectations rise, Warsh faces communication test
The Fed's policy projections released last month showed officials leaning toward one more hike this year. Wolfe Research chief economist Stephanie Roth said the Fed will almost certainly stay put this month. However, after September consumer and producer price data, she believes Warsh and other Federal Open Market Committee members are deepening their inflation concerns, still intend to hike further and may subtly signal that through wording. Warsh has avoided hinting at policy decisions in advance. Earlier this month, during the International Monetary Fund annual meetings, he said he was unwilling to pre-announce what he might do at remaining meetings this year and said the Fed is entering a new phase in which it no longer operates by providing advance rate guidance.
But that communication style carries risks. Investors want to know when the Fed will act again; if Warsh refuses to provide enough information, markets could still swing sharply on the lack of clear signals even if the rate decision meets expectations. Santander U.S. Capital Markets chief economist Stephen Stanley told Bloomberg he expects the Fed to hold steady this time and hike in December; the difficulty is that Warsh must explain why it is not acting in October while also explaining why a December hike remains possible.
This is not purely a wording issue. The Fed already hiked by 25 basis points in September, and all voters supported the decision at the time. If it pauses now, markets need to know whether officials believe the September hike was enough to buy time or whether their view of the economy and inflation has changed.
Official divisions may offer clues on hawkishness
The Fed is also divided internally on the timing of hikes. When the central bank decided to keep rates unchanged in July, three regional Fed presidents dissented in favor of a 25 basis point hike. Gapen expects two officials may dissent against holding rates steady this week; a smaller number of dissents could be seen by markets as a dovish signal, while if three still support a hike, it could be read as hawkish. Cleveland Fed President Beth Hammack has warned that repeated supply shocks could lead businesses and households to expect persistent price increases, making inflation harder to control. Minneapolis Fed President Neel Kashkari stressed that after years of supply shocks, containing inflation remains the central bank's duty. Dallas Fed President Lorie Logan also said earlier this month that further hikes are still needed, but rising Treasury yields may help slow economic growth and thus partly tighten financial conditions.
Energy prices are another key variable. The Middle East conflict continues to pressure oil and diesel markets, and Gapen believes Warsh will not ignore the second-round effects of higher energy prices, namely how cost pressures pass through to broader goods and services prices. Gapen believes the economy can withstand an additional 75 to 100 basis points of hikes, but if cumulative hikes reach six to seven times and bring rates back to 2023 levels, the economic situation would be very different. He favors the Fed hiking every other meeting and assessing data between moves, with energy market trends affecting that pace.
In addition, Warsh has announced a working group of outside experts to study the Fed's press conference arrangements and other communication mechanisms. The September press conference was noticeably shorter than usual, and the range of media asking questions was also expanded. Whether communication methods continue to adjust at this meeting is also worth watching. For markets, the core question at this week's meeting is therefore not just whether the Fed pauses, but whether the pause means the policy cycle is about to end. If officials continue to stress inflation risks while keeping the December hike option open, the overall policy signal could still lean hawkish even if rates stay unchanged for now.
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