In a move that surprised few, the Federal Reserve announced its decision to keep the Overnight Federal Funds Rate steady at its range of 5.25% to 5.50% in its latest meeting.¹ This marks the second consecutive meeting where the central bank has chosen to maintain the status quo in monetary policy.

“As highly anticipated, the Fed left their policy rate unchanged at 5.25%–5.5%, furthering the hawkish pause and expressing that rates remain at a restrictive level. This move further supports our view that the market has likely seen the last hike of the tightening cycle,” remarked Ajene Oden, Global Investment Strategist for J.P. Morgan’s Global Investment Strategy team.

However, Fed Chairman Jerome Powell made it abundantly clear in his remarks following the announcement that this decision should not be mistaken for a signal that the Fed is done with its tightening cycle. According to Powell, the central bank intends to retain the option of another rate hike if data indicates that inflation's slow decline over the last year has stalled.

Inflation outlook

The Fed's favored metric for inflation, the Personal Consumption Expenditures (PCE) price index, showed a modest cooldown in September.² The core index, which excludes food and energy prices, rose by 3.7% over the 12 months ending in September, down slightly from the 3.8% rate observed in August.

While this indicates a slight deceleration, inflation remains a key concern for the central bank. Inflation expectations are considered to be self-fulfilling in mainstream economic theory, and the Fed consciously crafts its policy message to make sure consumers, investors and other policymakers know the central bank will do almost whatever it takes to get inflation to its 2% target. If that means leaving rates higher for longer, so be it.³

Some hawkish Federal Open Market Committee (FOMC) members, like Philip Jefferson, recently softened their tone on the need to raise rates by saying higher bond yields will factor into their rate decisions going forward. Other members, like Patrick Harker of the Philadelphia Federal Reserve and Raphael Bostic of the Atlanta Federal Reserve, have argued that both monetary policy and rates in the market are high enough to bring inflation down to 2%.⁴

On this, Oden commented, “The addition of ‘tighter financial conditions’ to the FOMC’s post-meeting statement appears to acknowledge the impact higher treasury yields may have on households and businesses, and potentially substitute for further policy tightening.”

Economic resilience

The U.S. economy has demonstrated remarkable resilience, posting an annualized growth rate of 4.9% in the third quarter, which is the highest in two years. Consumer spending, often considered the engine driving the American economy, surged at its fastest pace since 2021. This robust economic performance underscores the strength of domestic consumption and indicates a robust foundation for continued growth.

Moreover, the labor market also continues to show signs of vigor, despite a year of monetary tightening. In September, employers added an impressive 336,000 jobs, marking the largest monthly gain since January. The unemployment rate held steady at a low 3.8% for that month. What’s more, wage growth continued to outpace inflation, although growth in wages has cooled off at nearly the same rate as price growth.⁵ These figures illustrate the ongoing resilience in job creation since the end of the pandemic, though in his news conference Powell indicated that the FOMC sees a moderating trend in labor as well.

Bond yields and financial conditions

Powell emphasized the role of soaring longer-dated bond yields in influencing the economy's trajectory. Treasury yields have been driven higher over the past year and a half by the Fed's actions. However, concerns have emerged regarding longer-dated yields, which are increasing due to a perceived lack of appetite among buyers for these extended maturities, a phenomenon known as "term premium," which represents the additional compensation investors demand for holding debt over an extended period.

The U.S. Treasury attributes this rise to expectations of sustained economic growth, highlighting a potential conundrum for the Fed. While continued growth is a positive indicator, it may also contribute to persistent inflationary pressures. Rising long-term yields may reduce the need for the Fed to continue increasing the overnight rate, however.

The bottom line

As the Federal Reserve stands at a critical juncture, the decision to maintain the Overnight Federal Funds Rate at its current level for the second consecutive meeting underscores the central bank's commitment to a balanced approach. While the U.S. economy exhibits impressive strength, the specter of inflation continues to loom.

“Although we tend to believe we’ve seen the last of Fed hikes for this cycle, the FOMC left the door open ‘in determining the extent of additional policy firming that may be appropriate to return inflation to 2% over time,’” noted Oden. The upcoming December meeting could potentially mark the final hike in this tightening cycle, as the Fed closely monitors economic indicators for signs of sustained inflationary pressures.

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