Federal Reserve October Meeting Preview: Expected to Hold Steady This Week, Waller Faces Major Communication Test, Market Focus Shifts to December

The Federal Reserve is highly likely to stand pat this week, but the real challenge lies in how Chair Walsh will explain this decision to the market while ensuring that expectations for a December rate hike remain intact.

Following the September rate hike, the inflation outlook has continued to deteriorate, but several officials have since delivered dovish speeches, lowering market expectations for a hike this week. Given that a large amount of key economic data will be released before the December meeting, investors are now betting that the second rate hike of the year will come in December.

The communication challenge is the core risk of this meeting. Walsh has consistently refused to provide forward guidance. At the July press conference, his overly cautious wording triggered market turbulence; although he corrected this in his August speech, this week he faces the need to re-strike a balance—he must both provide a reasonable explanation for holding rates steady and leave room for a December rate hike, all while avoiding any misinterpretation by the market of a softening policy stance.

According to FedWatch, the probability of the Federal Reserve standing pat this week is about 90%.

Since taking over the Federal Reserve in May, Walsh has adhered to a communication philosophy different from his predecessor: forward guidance is easily misinterpreted by the market as a promise on the future policy path, and should not be used lightly except in times of economic crisis.

His position is that when policy is in a period of minor adjustments, excessive guidance only undermines the central bank's flexibility, and investors should track economic data themselves to judge the direction of interest rates.

The cost of this stance became apparent in July. At that time, his vague remarks at the press conference unsettled the market, which was left without any commitment to anti-inflation actions. Walsh then attempted to remedy this with a speech in August, and in the September meeting, together with colleagues, proceeded with a rate hike and hinted at one more hike within the year through the quarterly dot plot.

However, in early October, New York Fed President Williams, Federal Reserve Vice Chair Philip Jefferson, and Board Member Christopher Waller all publicly spoke, saying the Fed has time to deliberate before the next rate hike. The market immediately slashed the probability of an October hike from over 70% to below 30%.

On October 16, when Walsh attended the IMF Annual Meeting, he had an opportunity to recalibrate expectations, but chose to stand pat, only stating that the situation since the September meeting was "broadly in line with expectations."

Making the situation even more tricky is the recent string of strong inflation data.

Persistently high oil prices, combined with wide spreads between crude and refined oil, have driven up both September consumer and producer prices. At the same time, strong investment demand driven by AI infrastructure construction continues to push up prices in consumer electronics, personal computers, and electricity.

Bank of America's head of U.S. Economics, Aditya Bhave, pointed out that the Fed's September hike was prompted by inflation concerns, "but since then, the overall inflation data has been even worse." He expects the Fed to surprise with a rate hike next week.

Nationwide Chief Economist Kathy Bostjancic also warned that if the Fed does not tighten policy, the spillover effect of rising energy prices could further spread, "and inaction could unnerve bond investors and cause long-term interest rates to become unanchored."

This meeting is also shrouded in a political shadow. The Fed's September rate hike drew harsh criticism from Trump, and if it acts again this week, with only days until the crucial midterm elections, the White House may respond even more sharply. Walsh will almost certainly deny that elections influence rate decisions, but this backdrop in itself constitutes an external constraint.

On the market front, the 10-year U.S. Treasury yield has held above 5% for more than a month, and although it has recently retreated, it has already placed significant pressure on mortgage, auto loan, and credit card borrowing costs. Since hitting a record high on October 6, the Nasdaq 100 index has fallen more than 7%, with AI-related tech stocks under particular pressure.

According to Bloomberg, citing analyst Anna Wong, higher borrowing costs are gradually filtering into the real economy, and if AI-related markets undergo major adjustments before or after the midterms, financial conditions could suddenly tighten.

Stephen Stanley, Chief Economist at Santander US Capital Markets, summarized the communication challenge of this meeting: "The tricky part is that Walsh must explain clearly why there is no rate hike in October while still convincing the market the December window remains open."