Fed's Powell Faces Pressure to Explain Rate Pause Amid Rising Inflation

Article by Xu Chao, Wall Street View

Inflation data continues to exceed expectations, yet the Fed is almost certain to hold steady this week.

This contradictory situation is focusing all the pressure on tonight’s press conference—how will Walsh explain to the market the decision to pause rate hikes despite clear inflation deviations from the target, without damaging the Fed’s policy credibility?

According to a recent Reuters survey, 94 out of 100 surveyed economists expect the Federal Reserve to hold interest rates steady at 3.75%-4.00% tonight. The implied probability of a rate hike, based on CME Federal Funds futures, is only around 10%, while Goldman Sachs’ equity volatility team estimates the swap-implied probability to be even lower at 7%.

However, inflation data does not support this position: in September, core CPI rose 0.3% month-over-month, exceeding the market expectation of 0.2%, and the annual rate increased to 2.6%; the three-month annualized growth rate of core CPI surged sharply from 2.0% to 3.4%. After the September CPI data release, the probability of an October rate hike briefly rose to around 50%—this sharp fluctuation itself reflects deep market uncertainty regarding the Fed’s path.

Bank of America Securities is currently Wall Street’s most prominent dissenter, with its economics team maintaining its October rate hike forecast, arguing that inflation data provides sufficient justification. In a report, Bank of America’s interest rate strategist Mark Cabana warned that if Powell chooses to pause but fails to provide a clear explanation, there is a risk of repeating the “dovish misstep” of the July press conference, which could place significant pressure on the dollar and the Treasury yield curve. For investors, the real uncertainty tonight lies not in the decision itself, but in every word Powell utters.

The core logic driving expectations for this pause stems from密集 signals released by Fed officials between meetings. According to Goldman Sachs’ Chief U.S. Economist David Mericle’s FOMC Outlook report, statements from FOMC members point to a consensus on tightening at a "every-other-meeting" pace—meaning an increase in September, a skip in October, and another hike in December.

New York Fed President John Williams clearly stated that "there is no urgency for action in October," suggesting that only one more rate hike remains this year and no further tightening is expected until 2027; Vice Chair Philip Jefferson said policymakers may need more time to assess the data; and Governor Waller summarized this stance as: rate hikes "do not need to occur at consecutive meetings, but should be implemented within a reasonable timeframe."

The FOMC meeting minutes further corroborated this framework: all 19 officials supported a rate hike in September, and "most" officials deemed another hike this year appropriate. This indicates that a December rate hike was the compromise outcome, while October was never genuinely under consideration—despite Walsh’s previous public remarks not explicitly ruling out that possibility.

Holding steady does not imply internal consensus. Several institutions expect multiple hawkish dissenting votes at this meeting.

Rabobank and Natixis both expect the three hawkish voters who opposed the pause in July—Cleveland Fed President Beth Hammack, Dallas Fed President Lorie Logan, and Minneapolis Fed President Neel Kashkari—to again vote together against the pause and support this 25-basis-point rate hike. JPMorgan Chase’s Chief U.S. Economist Michael Feroli anticipates at least two dissenting votes (Hammack and Logan), with Kashkari potentially joining them.

The hawkish arguments are well-supported. Logan believes rates need to be raised by another 50 basis points or more; Harker emphasizes that policy should move swiftly to a restrictive level, preferably in smaller, faster increments; and Boston Fed President Susan Collins (a non-voting member this time) noted that the probability of inflation remaining significantly above the 2% target is rising.

ANZ economist Brian Martin was this week’s most prominent hawkish voice on Wall Street, citing standards set by Powell himself in his Jackson Hole speech: “The FOMC must be confident that ‘underlying inflation is moving clearly and sufficiently toward our target, or our work is not done.’” He argued that the September CPI data did not provide such confidence, and that the market has significantly underestimated the probability of this rate hike.

In a market consensus where nearly all institutions expect a pause, Bank of America (BofA) is a rare outlier.

According to Bank of America’s FOMC Outlook report from its Rates and FX Research team, Bank of America economists maintain their forecast for an October rate hike, believing that persistent inflationary pressures should compel the Fed to continue tightening—although the team acknowledges that market pricing reflects a Fed willing to wait until after the election and confident in a more dovish inflation outlook.

Bank of America’s research team noted that an unexpected Fed rate hike would be the most hawkish surprise since 2009, occurring when market pricing was at its lowest level (around 3 basis points); historically, 90% of hawkish surprises occurred when market pricing was at least this high. Bank of America believes this would cause the 2-year U.S. Treasury yield to surge by 15–20 basis points and lead to a significant flattening of the yield curve.

Bank of America maintains its core trades of shorting 2-year U.S. Treasuries and flattening the 2s30s yield curve. Even if the outcome is a pause, the team believes that if Powell’s press conference lacks clarity, the 2s30s curve could experience a bear steepening of 5–7 basis points—approximately half the 12.5-basis-point steepening seen after the July FOMC.

Goldman Sachs economists are among the most dovish institutions on Wall Street; their baseline scenario still anticipates one more rate hike in December before ending this tightening cycle, and analysts believe the market's pricing of a cumulative 75 basis points of hikes by 2027 is overly aggressive.

Goldman Sachs' core argument is that the sources of inflation overshooting are temporary. According to David Mericle’s estimates, tariffs, energy shocks from Iran, and statistical errors related to AI-driven price changes collectively account for the entire 1.1 percentage point deviation of current core PCE from the 2% target. As these factors gradually fade, Goldman Sachs expects core PCE to return to approximately 2.2% by the end of 2027.

However, the latest data from the San Francisco Fed challenges this logic of "waiting for inflation to subside on its own."

According to Torsten Slok, Chief Economist at Apollo Global Management, citing this data, in today’s 3% core PCE inflation, demand-driven and supply-driven factors each account for half—whereas in 2022, supply-side factors were dominant. Slok emphasized that interest rate policy can cool demand-driven inflation but has limited impact on supply shocks, meaning that half of today’s inflation may not be solvable by waiting alone.

Regarding upside risks, Goldman Sachs is particularly focused on energy prices. Current oil prices are above Goldman Sachs’ own forecasts, reflecting market concerns about further deterioration in the Middle East. If oil prices follow the futures curve, core PCE inflation could rise by an additional 0.1 percentage point before March next year, while headline inflation could increase by approximately 0.4 percentage points. Goldman Sachs therefore cannot rule out a rate hike in March, but does not consider this its baseline forecast.

There was little suspense surrounding the outcome of this meeting; the market’s true focus was on Waugh’s press conference performance. During the July press conference, when pressed on “why not raise rates,” Waugh responded that data had “little” impact on decisions—prompting the first wave of sell-offs in long-term bonds.

Natixis expects this to be a “brief press conference with no Q&A and no in-depth explanations”; Goldman Sachs economists also “do not anticipate gaining any substantive new information from the press conference.” Will Marshall, Head of U.S. Interest Rate Strategy at Goldman Sachs, noted that the key lies in the balance of time allocated by Powell to inflation versus financial conditions: greater emphasis on inflation would reinforce curve flattening and push short-term rates higher, while greater emphasis on tightening financial conditions could lead to a steepening of the curve.

Michael Feroli provided Wash with a viable script: stating that “the committee leans toward rate hikes but wishes more time to observe the transmission effects of last month’s increase on the economy.” Feroli immediately pointed out the contradiction—this is essentially forward guidance, which Wash explicitly rejects. His warning is noteworthy: a decision to hold rates steady just under a week before the midterm elections, amid hot inflation data, will inevitably lead markets to associate policy with non-economic influences if not adequately explained.

In terms of wording, Goldman Sachs expects the FOMC to draw on Vice Chair Jefferson’s recent speech, adopting language similar to: “Any further rate adjustments will depend on data trends, the evolution of the outlook, and the balance of risks.” If Walsh considers this too close to forward guidance, an alternative would be to remain entirely silent on the policy path.