Wall Street bets on a rate hike, but the Fed decision could be a close call

Wall Street is largely expecting the Federal Reserve to raise interest rates this afternoon for the first time in more than three years.

Investors are betting on a nearly 93% chance the central bank raises rates by a quarter point to a new range of 3.75%-4%.

“The case for a rate hike is strong,” said Matt Luzzetti, chief US economist for Deutsche Bank, pointing to solid economic growth, a rebound in the job market, and inflation that’s shown limited evidence of falling back toward the Fed’s 2% inflation goal.

Inflation readings over the summer have shown some progress, but still suggest prices are stubbornly sticky, as oil climbs back over $100 a barrel amid renewed tensions in the Middle East.

Read more: How jobs, inflation, and the Fed are all related

“Forward-looking indicators, including from energy prices, suggest the inflation overshoot is likely to persist for some time,” he said. “Against this backdrop, it is not clear the Fed is sufficiently restrictive.”

While JPMorgan Chase chief economist Michael Feroli thinks it’s a closer call between whether the Fed hikes or holds rates steady, he noted that the Fed’s preferred inflation gauge — the core Personal Consumption Expenditures index (PCE), which excludes volatile food and energy prices — has been above 3% every month this year and has made little recent progress toward 2%.

He also noted the Fed could hike rates given that Fed Chairman Kevin Warsh’s “repeated stern warnings on inflation intolerance risk institutional credibility absent some action to back it up.”

Last month in Jackson Hole, Wyo., Warsh laid out a cogent case for raising rates. He noted that June and July inflation reports failed to prove prices are on a convincing downward path, adding that he would be hard-pressed to describe broad financial conditions as “restrictive.” Warsh also said his standard is that the Fed “must be confident that underlying inflation is moving to our objective, clearly and at sufficient speed. Otherwise, we have work to do.”

Feroli said while such statements are inconsistent with holding rates steady, there is a case for patience. He estimates that through August, the three-month annualized core PCE is 2.7% — not great, but moving in the right direction. Also, inflation expectations are stable, and there are no signs of overheating in the labor market.

And while many expect a hike, there is a chorus of contrarians who don’t think the Fed will raise rates at this meeting due to the upcoming midterms and political pressure, or they simply expect inflation to come down and the Fed won’t need to hike.

Moody’s chief economist Mark Zandi wrote on X that the Fed would be committing a policy mistake if it hikes because the forces driving up inflation are energy prices and tariffs — supply shocks that rate hikes can’t fix, and which should fade on their own.

He warned that if the Fed were to raise rates, it would hurt the employment side of its mandate. Zandi argued the central bank needs to rein in artificial intelligence in order to tame inflation, noting that AI-related investment is powering the economy, while the non-AI economy is already struggling.

“To hit its inflation objective, the Fed either needs to rein in the AI boom or put even more pressure on the rest of the economy,” Zandi wrote on X. “Neither is a good outcome. Of course, it doesn’t have to choose either. It can wait.”

Luzzetti said he expects the Fed will raise rates a total of three times — on Wednesday, then again in December and next March — which would unwind the three risk-management cuts made in the fall of 2025.

Feroli said he anticipates one more hike after Wednesday in December.

Whatever choice the Fed makes, Warsh will need to explain the choice in his press conference. Excluding Warsh, Fed officials will jot down their interest rate projections for the next few years, the so-called “dot plot.”

If the Fed does hike, many expect it will be a unanimous decision. If the Fed holds, expect the same trio of hawks to dissent as last time — Beth Hammack, Neel Kashkari, and Lorie Logan.

The Fed’s decision will be released at 2 p.m. ET Wednesday, followed by Warsh’s press conference at 2:30 p.m. ET.

Jennifer Schonberger is a veteran financial journalist covering markets, the economy, and investing. At Yahoo Finance, she covers the Federal Reserve, Congress, the White House, the Treasury, the SEC, the economy, cryptocurrencies, and the intersection of Washington policy with finance. Follow her on X @Jenniferisms and on Instagram.

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