The Fed left the rate unchanged — inflation and rising energy costs are increasing the risk of tightening

The U.S. Federal Reserve (Fed) left its interest rate unchanged on Wednesday, holding it within the 3.75%-4.00% range. The decision comes amid a challenging economic environment, as the central bank must simultaneously weigh inflation, rising oil prices, increasing borrowing costs, and risks stemming from massive investments in artificial intelligence.

The Federal Open Market Committee (FOMC) made the decision by a vote of 10 to 2. Governor Lisa Cook and Cleveland Fed President Beth Hammack favored raising the interest rate by 25 basis points. In September, the Fed raised the rate by 25 basis points — the first tightening of monetary policy since July 2023.

According to the committee's statement, U.S. economic activity is growing at a strong pace, domestic demand remains solid, and productivity growth and capital investment remain robust. At the same time, employment growth is in line with labor force expansion, and the unemployment rate has not changed significantly.

However, the Fed emphasized that inflation remains elevated, and additional economic data will be needed to determine what monetary policy stance would best support inflation's return to the 2% target.

Inflation and oil prices remain the Fed's main challenges

Despite leaving the rate unchanged, inflationary pressure remains strong. The U.S. Consumer Price Index (CPI) rose 3.7% year-over-year in September, up from 3.4% in August. Core inflation, which excludes food and energy prices, came in at 2.6%, compared to 2.4% in August.

The Fed prefers the Personal Consumption Expenditures (PCE) price index as its measure of inflation. In August, headline PCE rose 3.4% year-over-year, while core PCE rose 3%.

Inflationary pressure is being further intensified by the ongoing conflict in the Middle East, which remains a significant risk to energy supply. In September, rising gasoline prices in the U.S. accounted for more than half of the monthly increase in the overall consumer price index.

In addition, U.S. Treasury yields rose sharply following the September meeting, pushing up borrowing costs. Higher market interest rates exert pressure on economic activity similar to that of additional monetary tightening by the Fed.

Expectations for a December rate hike are growing

Investors' attention has now shifted to Fed Chair Kevin Warsh's press conference. Market participants are hoping to glean additional clues about future monetary policy from his remarks. Warsh is skeptical of forward guidance, making his responses regarding the assessment of economic data and possible policy decisions especially significant.

In September, Warsh stated that inflation is too high and has remained at this level for too long. He also noted that no meaningful progress had been made in reducing core inflation over the summer.

According to the minutes of the Fed's September meeting, most policymakers were considering another rate hike before the end of the year. Accordingly, market participants anticipate a possible further tightening of monetary policy in December. However, the final decision will depend on the subsequent trajectory of inflation, the labor market, and economic activity.