Guotai Haitong: Fed's "hawkish pause" rate hikes may still continue within the year

Guotai Haitong released a research report stating that the Fed kept rates unchanged at its October FOMC meeting, but a December rate hike is highly likely to proceed, and the short-term market has already been pricing in expectations of continued rate hikes to combat inflation after a "hawkish pause." The bank expects that if US-Iran tensions ease and a divided government emerges, 2027 could usher in an inflection point for looser liquidity. Guotai Haitong's main views are as follows: At 2:00 a.m. Beijing time on October 29, 2026, the Federal Reserve released its FOMC rate decision, followed by Warsh's press conference at 2:30. In summary, the bank believes there are five marginal changes in this FOMC rate decision and Warsh's remarks: First, the Fed is marginally more optimistic about the US economy. On the one hand, in the FOMC statement, the description of the economy since 2026 had consistently been "expanding at a solid pace," but this time it was changed to "expanding at a strong pace," a more emphatic formulation; on the other hand, Warsh expects US economic growth to rise further in Q3 2026, driven by strong consumer spending and business investment, with high-tech investment leading growth. Second, the Fed emphasized that inflation remains serious, reiterated the 2% PCE inflation target regime, and repeatedly stressed that this is the Fed's mandate. The rate statement said "inflation remains somewhat elevated," and Warsh also stated that inflation is still high, that there is no easing bias or implicit inflation target, and that achieving 2% year-on-year PCE inflation is the Fed's mandate. Third, this meeting kept rates unchanged, but there were dissenting votes in the rate decision, while any forward guidance on the future rate path continued to be avoided. The October 2026 FOMC meeting "held steady," keeping the federal funds rate target at 3.75%-4%, but the rate decision passed 10:2, with two officials voting against. Warsh strenuously avoided the question of whether the current rate level is sufficient, striving to avoid forward guidance. Fourth, advancing reform of the FOMC meeting system, with a dedicated working group about to play a role. Warsh announced that starting in autumn 2027, the FOMC will still hold 8 meetings per year, but one of them will be used to discuss monetary policy strategy without a rate vote, and in 2028 the monetary policy strategy meetings will increase to 2, with rate decisions correspondingly reduced to 6. Fifth, Warsh ruled out the influence of political factors such as the midterm elections on this meeting, emphasizing the Fed's independence. The bank expects that after the short-term rate hike pause, the Fed will most likely continue raising rates in December. The bank views the October "hold" as a short-term "hawkish pause." The reasons for pausing are: first, the Fed believes short-term financial conditions have already tightened; second, the Fed faces a balance between the economy and inflation, with recent employment data having weakened somewhat; third, energy prices are a fast-moving variable, and the Fed needs to remain flexible. The bank expects a 25bp rate hike in December is highly likely. On the one hand, the US federal funds rate futures market currently prices in about an 80% probability of a December hike; on the other hand, there are no signs of reversal in the short-term inflation impact from both supply and demand sides in the US (energy and AI demand, etc.), inflation is unlikely to decline smoothly in the short term, and rate hikes to combat inflation may still be needed. However, there remains considerable uncertainty over Fed monetary policy in 2027. The bank believes that if geopolitical tensions ease and a divided government emerges after the midterm elections, an inflection point for a liquidity reversal may arrive. In the short term, the market is pricing in expectations that rate hikes will continue to combat inflation after the "hawkish pause." On the day, short-end rates first fell then rose, long-end rates first rose then fell, and US stocks were pressured before rebounding. The bank believes that if US-Iran tensions ease and a divided government emerges, an inflection point for looser liquidity is likely to follow, and it is bullish on US Treasuries and US tech stocks. If after the midterm elections the US enters a divided government and a window for US-Iran de-escalation becomes visible, the bank believes an inflection point for looser liquidity will most likely arrive in 2027, and US Treasuries and US tech stocks may still be worth looking forward to. Risk warning: The trajectory of the US-Iran conflict remains highly uncertain; the US midterm election results may trigger short-term market volatility.