Tonight, the pressure falls on Warsh

Written by Xu Chao, Wall Street Insight

Inflation data continues to come in above expectations, yet the Fed is almost certain to hold rates steady this week.

This contradiction is concentrating all pressure on tonight's press conference—how Warsh will explain to markets the decision to pause rate hikes despite inflation clearly deviating from target, without undermining the Fed's policy credibility.

According to Reuters' latest survey, 94 of 100 economists surveyed expect the Fed to keep rates unchanged at 3.75%-4.00% tonight, with CME Fed Funds futures implying only about a 10% probability of a rate hike at this meeting, while Goldman Sachs' equity volatility desk estimates the swap-implied probability is even lower at 7%.

However, inflation data does not support this stance: September core CPI rose 0.3% month-over-month, above the 0.2% market expectation, while the year-over-year rate rose to 2.6%; the three-month annualized growth rate of core CPI surged from 2.0% to 3.4%. After the September CPI release, the probability of an October rate hike briefly rose to about 50%—this sharp swing itself reflects deep market uncertainty about the Fed's path.

BofA Securities is currently the most prominent dissenting voice on Wall Street, with its economists maintaining their October rate hike forecast and arguing that inflation data provides sufficient justification. BofA rates strategist Mark Cabana warned in a report that if Warsh chooses to pause but cannot provide a clear explanation, there is a risk of repeating the 'dovish misstep' at the July press conference, at which point the U.S. dollar and Treasury yield curve could face significant pressure. For investors, the real suspense tonight is not the decision itself, but every word Warsh chooses.

Consensus forming: an implicit 'hike every other meeting' agreement

The core logic driving the expectation of a pause comes from a dense stream of signals released by Fed officials between meetings. According to Goldman Sachs' chief U.S. economist David Mericle's FOMC preview report, comments from FOMC members point to a consensus to advance tightening at a 'hike every other meeting' pace—that is, a rate hike in September, a skip in October, and another hike in December.

New York Fed President John Williams explicitly stated that there is 'no urgent need for action in October' and suggested that only one more rate hike remains this year, with no further tightening until 2027; Fed Vice Chair Philip Jefferson said policymakers may need more time to assess data; Governor Waller summarized this stance as rate hikes 'do not need to come at consecutive meetings, but should be in place within a reasonable timeframe'.

The FOMC minutes also confirm this framework: all 19 officials supported the September rate hike, and 'most' officials considered another rate hike within the year appropriate. This means a December rate hike is the landing point of compromise for all sides, while October was never truly on the table—although Warsh's own wording in previous public speeches did not explicitly rule out this possibility.

Hawkish dissents: three opposing votes may reappear

A hold does not mean internal unity. Several firms expect multiple hawkish dissents at this meeting.

Rabobank and Natixis both expect the three hawkish members who voted against the pause in July—Cleveland Fed President Beth Hammack, Dallas Fed President Lorie Logan, and Minneapolis Fed President Neel Kashkari—to join forces again in opposition, supporting a 25 basis point rate hike at this meeting. JPMorgan's chief U.S. economist Michael Feroli expects at least two dissents (Hammack and Logan), with Kashkari possibly joining them.

The hawks' arguments are not without support. Logan believes rates need to be raised by 'another 50 basis points or more'; Hammack emphasized the need to move to a restrictive policy level as soon as possible, preferably in smaller increments and at a faster pace; Boston Fed President Susan Collins, who is not a voting member this time, also noted that the probability of inflation persisting significantly above the 2% target is rising.

Australia and New Zealand Banking Group (ANZ) economist Brian Martin is the most prominent hawkish voice on Wall Street this week, citing in his report the standard Warsh himself set in his Jackson Hole speech: 'The FOMC must be confident that underlying inflation is moving toward target at a clear and sufficient pace; otherwise, our job is not done.' He believes September CPI data did not provide such confidence, and the probability of a rate hike at this meeting is significantly underestimated by the market.

BofA Goes Against the Consensus: A Contrarian Bet on an October Rate Hike

Amid market consensus that almost every institution expects a pause, Bank of America (BofA) is a rare outlier.

According to BofA's rates and FX research team's FOMC preview report, BofA economists maintain their forecast for an October rate hike, arguing that persistent inflation pressures should drive the Federal Reserve to continue tightening—although the team also acknowledges that market pricing reflects a Fed willing to wait until after the election and confident in a more dovish inflation forecast.

BofA's research team notes that if the Federal Reserve unexpectedly hikes rates, it would be the biggest hawkish surprise since 2009 at a time when market pricing is at its lowest (about 3 basis points); historically, 90% of hawkish surprises have occurred when prior market pricing was at least above this level. BofA believes such a move would cause the 2-year Treasury yield to jump 15-20 basis points and the curve to flatten sharply.

BofA maintains its core trades of shorting 2-year Treasuries and flattening the 2s30s curve. Even if the final outcome is a pause, the team believes that if Warsh's press conference remarks are insufficiently clear, the 2s30s curve could bear steepen by 5-7 basis points—about half the 12.5-basis-point steepening seen after the July FOMC.

Goldman Sachs: Rate-Hike Cycle Ends in December

Goldman Sachs economists are among the most dovish institutions on Wall Street, and their base case remains one more rate hike in December before this tightening cycle ends; analysts believe the cumulative 75 basis points of rate hikes priced into 2027 is overly aggressive.

Goldman Sachs's core argument is that the sources of above-target inflation are temporary. According to David Mericle's estimates, tariffs, the Iran energy shock, and statistical distortions in AI-related prices together explain the full 1.1 percentage points by which current core PCE inflation exceeds the 2% target. As these factors gradually fade, Goldman Sachs expects core PCE to fall back to about 2.2% by the end of 2027.

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

Apollo Global Management Chief Economist Torsten Slok, citing the data, noted that of the current 3% core PCE inflation, demand-driven and supply-driven components each account for half—whereas in 2022, the supply side was the dominant factor. Slok emphasized that interest-rate policy can cool demand-side inflation but has limited effect on supply shocks, meaning that perhaps half of current inflation cannot be resolved simply by waiting.

On the upside-risk side, Goldman Sachs is particularly focused on energy prices. Oil prices are currently above Goldman Sachs's own forecasts, reflecting market concerns about further deterioration in the Middle East. If oil prices follow the futures curve, core PCE inflation would rise by an additional about 0.1 percentage points by next March, while headline inflation would increase by about 0.4 percentage points. Goldman Sachs therefore does not rule out a March rate hike, but it is not its base-case forecast.

Warsh's Challenge: The Press Conference Is the Real Test

The outcome of this meeting's decision is almost a foregone conclusion; the market's real focus is Warsh's performance at the press conference. At the July press conference, when pressed on 'why not hike,' Warsh replied that the impact of data on decisions was 'not much, in two words,' triggering the first wave of the long-term bond selloff.

Natixis expects this to be 'a short press conference, with no Q&A session and no deep explanation'; Goldman Sachs economists likewise 'do not expect to get material new information from the press conference.' Goldman Sachs Head of U.S. Rates Strategy Will Marshall pointed out that the key is the proportion of time Warsh devotes to inflation versus financial conditions: more emphasis on inflation would reinforce curve flattening and push front-end rates higher, while more emphasis on tighter financial conditions could lead the curve to re-steepen.

Michael Feroli provided Warsh with a workable script, saying the Committee was leaning toward raising rates but wanted more time to observe the transmission effects of last month's rate hike on the economy. Feroli then highlighted the contradiction—this is essentially forward guidance, which Warsh has explicitly refused to provide. His warning is telling: a decision to hold rates steady less than a week before the midterm elections and amid hot inflation data, if not adequately explained, would inevitably lead markets to infer that policy was being swayed by non-economic factors.

In terms of statement wording, Goldman Sachs expects that the FOMC may draw on Vice Chair Jefferson's recent speech and adopt language similar to 'Any further adjustment to interest rates will depend on data trends, the evolving outlook, and the balance of risks.' If Warsh views this as too close to forward guidance, another option would be to remain completely silent on the policy path.

Source: TechFlow