Fed review: Fed pauses, but tightening cycle is not over

The FOMC's 10-2 split decision was in line with the expectations we set out in our Fed Preview, 22 October, where we called for 2-3 dissenters. We expected Hammack, though not Cook to dissent. If anything, Cook's dissent expands the group of voters willing to dissent when they deem it appropriate.

The statement was short, as usual. The wording was largely unchanged from the September meeting, though a slight hawkish shift from "economic activity is expanding at a solid pace" in September to "economic activity is expanding at a strong pace" today.

Warsh's comments on the economic outlook sounded quite hawkish. He said growth had strengthened with growth above 3% in Q3. He also noted strong consumption growth and said business investment is probably rising by a double-digit percentage. Warsh did not give any specific comments on the future rate path. Several times he flagged the tightening of financial conditions since September, which we flagged as our main argument for why the Fed could wait before delivering the next hike.

Neither the decision, the vote split nor the details from the press conference gave us information that would lead us to change our forecast for two further 25bp hikes at the December and March meetings, respectively. If anything, Warsh seems to prefer having more data points between rate decisions, which we think slightly supports our call for gradual hikes with pauses between meetings, rather than hikes at back-to-back meetings. Nevertheless, the risk is still tilted towards more than two hikes. If inflation shows further signs of broadening and underlying inflation increases more rapidly, we think the Fed will not be afraid to hike rates at back-to-back meetings.

The FOMC agreed to change the format of some meetings from autumn 2027 and onwards. At one meeting in autumn 2027, no rate decision will be taken. From 2028, two of the eight annual meetings will not include a rate decision. We think this further supports our case for gradual rate hikes rather than back-to-back moves. The FOMC did not specify, which meetings would change format.

Warsh flagged some details on the work of the five task forces he created at his first press conference after his appointment at the June meeting. He said some, but not all, would have recommendations ready by the year-end deadline he set. The productivity task force will hold a hearing on 16 November, while the balance sheet task force will have recommendations ready in early Q1. We focused on the inflation task force in our latest Reading the Markets USD - The return of money, credit and debt to Fed's inflation analysis, 27 October.

Warsh's lack of commitment to a December hike caused the UST yield curve to steepen, as front-end rates dropped and breakeven inflation expectations rose. Markets are now pricing in only 21bp for the December meeting, down from 23-24bp beforehand. The following hike is now fully priced only by April, previously March. EUR/USD spot rose back above 1.1150, while the forward curve declined slightly during the press conference. We still call for two more hikes in December and March and maintain our bearish view on EUR/USD spot, with a 6-12M target of 1.10.