The Federal Reserve entered its October 27–28 meeting following September's 25-basis-point rate increase, which brought the federal funds target range to 3.75%–4.00%. Inflation has ticked higher, while economic growth and labor market conditions have shown continued resilience. Although markets broadly anticipated a pause in October, the probability of another rate increase in December remained above 80%, according to Bloomberg. The central question is whether the Fed views a pause as an opportunity to assess the effects of tighter policy or as a signal that interest rates may be approaching their peak.
- Does an October Pause Indicate a Change in the Fed's Policy Direction?
The Fed remains on a hiking path, but the timing is unclear. There were two dissents for a hike at the October 28, 2026, meeting: Beth Hammock, who also dissented from July’s decision to hold, and Lisa Cook, a new dissenter that surprised most Fed watchers. The reasons given for holding rates at this meeting were not entirely clear. Chair Warsh said that financial conditions had tightened since the hike in September but that he couldn’t call them “tight.” He also acknowledged that inflation remains above target and that the Fed has more work to do to achieve price stability. Economic activity is strong and has likely accelerated in the third quarter.
- Is Inflation Keeping the Fed on a Tightening Path?
We believe, with the labor market remaining resilient and economic activity strengthening, the Fed’s main focus is on the inflation side of the mandate. Chair Warsh said that the Fed needs to ensure that the rise in energy prices does not broaden out. However, that message is difficult to reconcile with the Fed's decision to hold rates steady, particularly after September's core CPI rose 0.3% versus expectations of 0.2%, while the core PPI increased 0.7% versus expectations of 0.3%. The Fed is watching market-based inflation expectations closely and was comforted by longer-term inflation expectations remaining unchanged since the September increase in the fed funds target rate, despite energy prices continuing to rise.
- How Resilient Is the Economy to Higher Interest Rates?
The economy has already proven to be quite resilient to higher interest rates. The good news is that the U.S. economy did not experience a recession that most had predicted after the Fed’s aggressive hiking cycle in 2022-2023. The primary interest-rate-sensitive area of the economy is housing, which never recovered after 2023 and remains at a standstill. Therefore, the housing sector is unlikely to be a source of further slowdown during the current hiking cycle. Economic growth in the past year has been quite dependent on artificial intelligence- (AI) related investment and spending. Chair Warsh said that he sees signs that growth is broadening out and consumer spending has been resilient in the face of higher gasoline prices. When asked about the sensitivity of growth to interest rates in the press conference, Chair Warsh replied that he is skeptical of the view that AI-related spending and investment is immune to increases in interest rates. He made the argument that September’s rate hike and the expectation for further hikes caused equity declines and credit spread widening in some of the AI-related names after the meeting. He said he believes that rate hikes will cause investors to be more discerning about AI-related financing. However, that is a difficult argument to establish ex ante, given the many factors influencing equity prices and credit spreads, in our view.
- Did the Fed Provide Any Indications About December and 2027?
Chair Warsh remained steadfast in his refusal to provide any forward guidance about future rate hikes. However, he did make a surprise announcement about the meeting schedule in 2027 and 2028. Starting next fall, one of the eight FOMC meetings in 2027 will be designated as a “strategy” meeting in which no decision on policy will be made. Instead, the committee will use that meeting to discuss its monetary policy framework more broadly, and it may not result in any public communication. In 2028, two of the eight meetings will be strategy meetings, with only six meetings resulting in a policy decision. This should not have any impact on the total number of rate hikes or cuts the Fed can achieve. The Fed retains the flexibility to adjust interest rates between scheduled meetings if necessary. The main impact could be a reduction in transparency and communication, resulting in more uncertainty about the Fed’s current views and reaction function.
- Are Tighter Financial Conditions Influencing the Fed's Next Move?
The recent tightening in financial conditions was the main reason cited for the Fed remaining on hold at this meeting. This Fed under Chair Warsh has been clear that it will incorporate signals from market movements in its policy decisions. The pause in hikes at this meeting could be interpreted as the Fed allowing the market to do its work for it and waiting to see if financial conditions tighten on their own. But this approach carries some risk, as it depends on a hawkish feedback loop in which markets must believe the Fed will continue raising rates for further hikes to be priced in. If the market loses faith in the Fed’s commitment, that feedback loop could break down.
- Could the Midterm Elections Influence Monetary Policy and Markets?
In the press conference, Chair Warsh was adamant that the upcoming midterm elections had zero bearing on the Fed’s decision to hold rates. While political developments may influence market expectations and financial conditions, monetary policy decisions are intended to remain independent of electoral considerations. In general, we do not anticipate a significant reaction in yields to the election results, primarily because a large change in fiscal policy is unlikely under any of the possible outcomes. For example, a divided Congress could make it more difficult to pass major spending or tax legislation, limiting the potential impact on interest rates.
- What Does the Policy Outlook Mean for Fixed Income Investors?
With the 10-year U.S. Treasury yield above 5%, historical data suggest an attractive starting point for forward fixed income returns.1 Additionally, recent volatility in credit and equity markets has also seen Treasury yields and risk assets move in the same direction, signaling a return to a positive correlation. This means that as equity prices declined, Treasury yields also fell, causing Treasury bond prices to rise. This suggests that duration may once again potentially provide diversification benefits in a multi-sector portfolio, acting as a hedge as gains from interest-rate-sensitive bonds could help offset losses in risk assets during periods of market stress. However, the effectiveness of this hedge depends on market conditions, including the Fed maintaining credibility in its commitment to price stability.