Fed October Rate-Hike Odds Fall Below 15% Despite Inflation Surge as Markets Bet on Pause

The odds of a Federal Reserve rate increase in October have fallen, strengthening market expectations that policymakers will hold rates steady.

Bloomberg reported on October 25 that the probability of an October rate hike implied by interest-rate swaps had dropped below 15%. The move reflects fading expectations for additional tightening as artificial-intelligence shares have slumped and concerns about slowing US economic growth have grown.

The Fed raised its benchmark rate in September for the first time in about three years. Persistent inflation pressures had prompted speculation about additional increases in October and December, but that view began to shift after senior Fed officials repeatedly struck a cautious tone.

John Williams, president of the Federal Reserve Bank of New York, said on September 29 that one additional rate increase this year could be appropriate. Fed Vice Chair Philip Jefferson and Governor Christopher Waller then indicated there was no need to rush further hikes. As a result, the implied probability of an October increase fell from as high as 70% to around 25%.

The US consumer price index released on October 14 posted its fastest increase in five months, triggering market volatility. The perceived odds of a rate hike surged from about 20% to around 50% immediately after the data, but investors later gave back most of that increase as they focused on signals that the Fed would pause.

Fed Chair Kevin Warsh said at the International Monetary Fund's annual meeting on October 16 that he would not prejudge future rate decisions. Still, markets took note that Warsh did not forcefully reject expectations for an October pause even after the inflation data.

Experts said there is a disconnect between economic data and the Fed's policy signals. Ed Al-Hussainy, a portfolio manager at Columbia Threadneedle, said the economic data support a rate increase and that Fed commentary is the only factor separating a hike from a pause.

Neil Dutta, head of economics at Renaissance Macro Research, said there was also a gap between Warsh's message and those of other Fed officials, raising the risk of greater market volatility around each policy meeting. Jamie Patton, co-head of global rates at TCW Group, said markets need to know the rules, but do not right now.