SWHY has released a research note maintaining its base case assumption of a 25 basis point rate hike by the Federal Reserve in December.
On one hand, U.S. inflation in the fourth quarter may enter a "plateauing phase," driven primarily by base effects and elevated oil prices, and Warsh has 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 comes in strong, employment remains stable, and market pricing suggests a high probability of a hike, a December rate increase landing may still be the base case, according to SWHY.
The main viewpoints of SWHY are as follows: On local time October 28, the Federal Reserve released its October meeting decision, with key points: 1) rates were kept unchanged, but Cook and Hammack cast dissenting votes; 2) starting from 2027, the FOMC meeting schedule will be adjusted, keeping the total of eight meetings per year unchanged but reducing the number of rate-setting meetings; 3) Warsh stated that tightening financial conditions are in line with expectations, and holding steady in October was aimed at gathering more information.
October Meeting Holds Rates Steady, Market Rate Hike Expectations Cool Slightly
The October FOMC meeting kept rates unchanged, but Cook and Hammack cast dissenting votes, favoring a 25 basis point hike. On the fundamentals front, the October meeting statement emphasized economic strength, with more optimistic wording than in September, though assessments of productivity, investment, and inflation remained unchanged. Regarding 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 voting outcome, two dissenting votes emerged at this meeting, indicating that there is still demand for tightening within the Fed and that the rate hike cycle has not ended.
Under the Fed's "wait-and-see" tone, market rate hike expectations cooled slightly. After the Fed statement was released at 2:00 AM Beijing time on October 29, asset prices showed little immediate change, but after the press conference began at 2:30 AM, 2-year U.S. Treasury yields and the dollar index fell while gold prices rose. During the press conference, Warsh stated that tightening financial conditions were in line with expectations and that more information would help determine the appropriate policy stance, which the market interpreted as a dovish signal. Notably, 10-year U.S. Treasury yields showed a volatile trend, diverging from the movement in 2-year yields.
FOMC Meeting Mechanism Reform Is the Biggest Marginal Change This Time
In the opening remarks of the press conference, Warsh announced that the FOMC meeting schedule would be adjusted starting from 2027. The Fed will still retain eight meetings per year, but in 2027, one meeting will focus on long-term policy strategy without voting or issuing a policy statement, increasing to two such meetings in 2028. In other words, traditional "rate-setting" meetings will be reduced to seven in 2027 and six in 2028. Warsh believes the U.S. economy is strong, AI investment is spreading, employment is solid, and strong growth does not necessarily push up inflation. Warsh pointed out that the economy further accelerated in the third quarter, high-tech investment is spreading to other sectors, and employment performance is good. Real-time forecast data shows that U.S. economic growth in the third quarter may exceed 3%. As early as the second quarter, U.S. equipment investment data already showed that AI investment is spreading to traditional industries. On the employment front, against a backdrop of weak labor supply, the U.S. unemployment rate and nonfarm payroll additions have both maintained stable levels.
Tightening financial conditions are in line with expectations, and the Fed can afford to be patient. Regarding the question of "why not hike at this meeting," Warsh offered two reasons: first, decisions are not based on a single date or data point; second, inflation compensation and inflation expectations are moving in the right direction. On the question of "whether there will be a hike in December," Warsh also made two points clear: he does not support using forward guidance in normal times, and he would not confirm whether there will be a December hike nor update forecasts on behalf of other committee members. However, Warsh did not deny that a December hike is the "consensus" of most committee members.
With Sticky Q4 Inflation, December Rate Hike Probability Remains High
We maintain our base case assumption of a 25 basis point Fed rate hike in December. On one hand, U.S. inflation in the fourth quarter may enter a "plateauing phase," driven primarily by base effects and elevated oil prices, and Warsh has also acknowledged that energy prices have risen again in recent weeks. On the other hand, apart from Cook and Hammack who cast dissenting votes this time, the "wait-and-see faction" within the committee is not dovish. If inflation data comes in strong, employment remains stable, and market pricing suggests a high probability of a hike, a December Fed rate increase landing may still be the base case.
Currently, Fed tightening remains in the "first half," namely "compensatory" rate hikes. The current inflation problem lies in the fact that underlying inflation is not converging quickly enough, making rate hikes "compensatory" in nature, with the goal of returning interest rates to neutral levels, characterized by follow-through and discretionary decision-making. 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, a "second half" rate hike by the Fed represents a medium-term "tail risk."
Risk warnings: a larger-than-expected upward shift in the central crude oil price range; Warsh's policy stance being "more hawkish"; U.S. economic slowdown exceeding expectations.
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