Fed buying time while awaiting task forces
Statement: As expected, the FOMC decided to maintain the target range for the federal funds rate, and only a few changes were made to the statement. The characterization of the economy shifted from “solid” to “strong,” but this change carries little meaning with the text describing domestic spending, capital investment, productivity, and the labor market remaining the same. The short note on inflation was also unchanged, but it was followed by the addition of “The accumulation of more information will help the Committee determine the policy stance appropriate to ensure a timely return to the Committee’s 2 percent goal.” This may be the first evidence of the Fed shifting away from Powell’s standard of “data dependence” and toward Warsh’s “frameworks” model, but time (and task forces) will tell.
Noteworthy was the dissent of Lisa Cook, who voted to hike at the October meeting. Beth Hammack’s dissenting vote was expected, though the extremely low market probabilities of a hike perhaps dissuaded Lorie Logan and Neel Kashkari given their backgrounds in financial markets. However, if inflation remains above target and financial conditions stay relatively loose, Logan and Kashkari will likely vote to raise rates at the December meeting.
Presser: During the Q&A, Chair Warsh didn’t mention his usual “inflation is a choice,” but instead focused on financial conditions. He fell short of describing current conditions as tight, but did acknowledge that they have tightened, already giving credit to the action taken at the last meeting in September. Chair Warsh stressed that higher rates and tighter financial conditions are increasingly showing up through the availability and cost of credit, providing a transmission mechanism from policy to activity. We tend to agree with this view and believe that there is heightened interest rate sensitivity in tech investment. The current FOMC may not be collectively chanting the “long and variable lags” mantra of monetary policy with inflation expectations anchored and tighter financial conditions already restricting credit.
Chair Warsh made it a point to stress the strength of the economy, but that most members of the Fed do not believe the economy is running too hot, making the distinction between growth and inflation particularly important. If stronger activity increasingly reflects better productivity and a higher potential growth rate, rather than excess demand spilling into inflation, then the need for an aggressive hiking cycle is lower than the stronger growth data alone might suggest.
The Chairman also mentioned updates to the 2027 and 2028 meeting schedule, highlighting that progress is indeed being made by the task forces. We may get another update on the productivity task force as early as November 16 and an update on the balance sheet in Q1 2027. The policy rate is currently the primary tool to conduct monetary policy, but again, time (and task forces) will tell if that remains.
Implications: The post-FOMC curve steepening reinforces our view that the move in longer-term rates is increasingly a re-rating of growth and term premium, rather than inflation. The Fed is not signaling urgency to hike at every meeting, while Warsh's stronger growth assessment has supported higher long-end yields. Yet the behavior of duration is changing. Strong 10s/30s auctions, Treasuries rallying through hot CPI, and several sizeable rallies this month suggest investors are increasingly willing to buy dips. With higher rates already tightening financial conditions and credit availability, duration appears better supported than it was earlier in the cycle.
Against that backdrop, December is not a done deal. Markets price roughly an 80% chance of a 25bp hike versus our 55% probability, leaving us meaningfully below market conviction. A lot can change before the meeting, particularly around the election, incoming data, financial conditions and inflation expectations.
Source: MUFG US Macro Strategy