Tonight's Federal Reserve decision: Inflation is heating up, but has the rate hike been paused? Waller faces a credibility test

Inflation data continues to exceed expectations, yet the Federal Reserve is almost certain to hold rates 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 inflation deviating clearly from the target, while safeguarding the credibility of the Fed's policies?

According to the latest Reuters survey, 94 out of 100 economists surveyed expect the Fed to maintain rates at 3.75%-4.00% tonight, with the probability of a rate hike implied by CME Fed Funds futures at only about 10%, and Goldman Sachs’ equity volatility desk estimating the swap-implied probability even lower at 7%.

However, the inflation data does not support this stance: Core CPI rose 0.3% month-on-month in September, above market expectations of 0.2%, and the annual rate increased to 2.6%; the three-month annualized growth rate of core CPI also surged from 2.0% to 3.4%. After September’s CPI data was released, the probability of an October rate hike briefly spiked to about 50%—this sharp swing itself reflects the market’s profound uncertainty regarding the Fed’s path forward.

BofA Securities is currently the most prominent dissenter on Wall Street, with its team of economists maintaining a rate hike forecast for October, believing there is sufficient justification in the inflation data. In a report, BofA rate strategist Mark Cabana warned that if Walsh pauses but cannot provide a clear explanation, there is a risk of repeating the “dovish mistake” from the July press conference, which could place significant pressure on the dollar and the Treasury yield curve. For investors, the real suspense tonight lies not in the decision itself but in Walsh’s every word.

The core logic supporting this pause expectation derives from the intensive signals released by Fed officials between meetings. According to Goldman Sachs chief U.S. economist David Mericle’s FOMC preview, FOMC members’ speeches point to a consensus: continuing tightening at a pace of “hiking at every other meeting”—raising rates in September, skipping October, and hiking again in December.

New York Fed President John Williams has explicitly stated there is “no urgent action needed in October,” and suggested there would be only one more hike this year with no further tightening until 2027; Federal Reserve Vice Chair Philip Jefferson mentioned policymakers may need more time to assess the data; Governor Waller summed up this stance as: rate hikes “do not need to occur at consecutive meetings, but should be implemented within a reasonable timeframe.”

The FOMC minutes confirm this framework: all 19 officials supported the September hike, and “most” believed one more hike this year would be appropriate. This suggests a December hike is the compromise point for all sides, and October was never seriously on the table—even though Walsh’s previous public remarks never directly ruled out this possibility.

Pausing does not mean unanimity inside the committee. Several institutions expect multiple hawkish dissents in this meeting.

Rabobank and Natixis both expect the three hawkish members who voted against pausing in July—Cleveland Fed President Beth Hammack, Dallas Fed President Lorie Logan, and Minneapolis Fed President Neel Kashkari—to again oppose the pause and support a 25 basis point rate hike this time. JPMorgan chief U.S. economist Michael Feroli expects at least two dissenting votes (Hammack and Logan), with Kashkari possibly joining as well.

The hawks have ample support for their arguments. Logan believes rates need to “increase by another 50 basis points or more”; Hammack emphasizes the need to “move to a restrictive policy level as quickly as possible, with smaller and faster increments”; Boston Fed President Susan Collins (not a voting member this time) also noted the probability of inflation continuing to significantly deviate from the 2% target is rising.

ANZ economist Brian Martin is the most prominent hawkish voice on Wall Street this week. In a report, he cited the standard articulated by Walsh at Jackson Hole: “The FOMC must be confident that ‘underlying inflation is clearly and sufficiently returning to target—otherwise our job is not done.’” He believes the September CPI data did not provide this confidence, and that the probability of a hike is being significantly underestimated by the market.

Amidst a market consensus where almost all institutions expect a pause, Bank of America (BofA) stands out as a rare exception.

According to BofA’s rates & FX research team’s FOMC preview, BofA economists maintain their forecast for an October hike, arguing that ongoing inflationary pressures should drive the Fed to continue tightening—although the team also acknowledges that the market is priced for a Fed “willing to wait until after the elections” and confident in its dovish inflation forecasts.

BofA’s research team points out that if the Fed surprises with a hike, it would be the largest hawkish shock since 2009 at a time when market pricing is at its lowest (about 3 basis points). Historically, 90% of hawkish surprises occurred when pre-meeting pricing was at least higher than this level. BofA believes this would send the 2-year U.S. Treasury yield surging 15-20 basis points and significantly flatten the curve.

BofA maintains its core trade of shorting 2-year Treasuries and positioning for 2s30s curve flattening. Even if the final result is a pause, the team believes if Walsh’s press conference language is not clear enough, the 2s30s curve could experience a bear steepening of 5-7 basis points—about half the 12.5 basis points seen after the July FOMC.

Goldman Sachs’ economists are among the most dovish on Wall Street, with their baseline scenario remaining a single additional rate hike in December to conclude the tightening cycle. Analysts believe the 75 basis point total rate hike priced into markets for 2027 is overly aggressive.

Goldman’s core argument is that the overshoot in inflation is temporary in nature. According to David Mericle’s calculations, tariffs, the Iran energy shock, and statistical errors in AI-related prices together explain the entire 1.1 percentage point overshoot in core PCE versus the 2% target. As these factors fade, Goldman anticipates core PCE will fall to about 2.2% by the end of 2027.

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

According to Apollo Global Management chief economist Torsten Slok, citing this data, half of the current 3% core PCE inflation is demand-driven and half is supply-driven—in contrast to 2022, when the supply side dominated. Slok emphasizes that interest rate policy can cool demand-side inflation but is less effective for supply shocks. This means that perhaps half of current inflation cannot be solved by waiting alone.

On the upside risk front, Goldman is particularly focused on energy prices. Current oil prices are above Goldman’s own forecast, reflecting market concerns about further deterioration in the Middle East. If oil prices follow the futures curve, core PCE inflation will be boosted by an additional 0.1 percentage points by March next year, while headline inflation will rise by about 0.4 percentage points. As such, Goldman does not rule out a rate hike in March, though this is not their baseline forecast.

The result of this meeting is almost a foregone conclusion; the real focus for markets is Walsh’s press conference performance. At the July press conference, when repeatedly questioned on “why not hike,” Walsh responded that the impact of data on decision-making was, “in two words, ‘not much,’” which immediately triggered the first wave of a sharp sell-off in long-term bonds.

Natixis expects this will be a “brief press conference, with no Q&A and no in-depth explanations”; Goldman Sachs economists also “do not expect substantial new information from the press conference.” Goldman’s U.S. rates strategy head Will Marshall points out that the key lies in how much time Walsh dedicates to inflation topics versus financial conditions topics: emphasizing inflation will reinforce curve flattening and lift front-end rates; greater emphasis on tightening financial conditions may cause the curve to steepen again.

Michael Feroli offers Walsh a set of feasible talking points: to say “the Committee is inclined to hike, but wants more time to observe the effects of last month’s hike on the economy.” Feroli immediately points out the contradiction—this is essentially forward guidance, which Walsh has explicitly declined to give. His warning is telling: a decision to hold rates steady made less than a week before the midterm elections, against a backdrop of hot inflation data, if not thoroughly explained, will inevitably lead markets to suspect policy has been swayed by non-economic factors.

Regarding the statement’s wording, Goldman expects the FOMC may borrow from Vice Chair Jefferson’s recent speech, adopting a stance like “any further rate adjustments will depend on data trends, the evolution of the outlook, and balance of risks.” If Walsh thinks this too closely resembles forward guidance, another option is to remain completely silent on the future policy path.