US Market: Fed expected to hold rates as Iran war fuels inflation concerns

ETMarkets.com

The policy decision comes less than a week before the US midterm elections, with the cost of living emerging as a major concern for consumers. Higher prices for gasoline, groceries, clothing and other essentials have weighed on consumer sentiment, adding to the challenges facing the central bank.

The Fed, led by Chair Kevin Warsh, is seeking to bring inflation back to its 2% target. The central bank raised its benchmark interest rate last month for the first time in three years, lifting it from around 3.6% to 3.9%, a move investors and economists viewed as the start of a renewed effort to contain price pressures, AP reported.

However, the outlook for further monetary tightening remains complicated. US President Donald Trump criticised the Fed for raising rates last month, directing much of his criticism at the rate-setting committee rather than Warsh, whom he appointed. Meanwhile, rising energy prices and the rapid expansion of artificial intelligence infrastructure are adding to inflationary pressures that higher borrowing costs may not easily address, according to AP.

Inflation pressures complicate Fed policy outlook

Inflation accelerated in September as the impact of higher energy prices fed into the economy. Consumer prices rose 3.7% year-on-year, compared with 2.4% in February, before the Iran war began, AP reported.

The consumer price index, the most closely watched measure of inflation, increased 0.3% in both August and September. If sustained over a year, that monthly pace would translate into inflation well above the Fed's 2% target.

A separate measure, the personal consumption expenditures price index, which the Fed uses to assess inflation, is expected to show a further acceleration. Economists forecast headline PCE inflation at 3.6% in September, compared with 3.4% in August. Core PCE inflation, which excludes food and energy, is projected to rise to 3.1% from 3%, according to AP.

Higher oil and gasoline prices could keep inflation elevated for several months, while rising diesel costs may increase shipping expenses and spread price pressures across a wider range of goods. Aditya Bhave, head of US economics at Bank of America, has warned that economists and the Fed may have become too comfortable with inflation remaining above target, AP reported.

Higher borrowing costs add to affordability concerns

While inflation remains persistent, higher interest rates are already weighing on parts of the US economy, particularly the housing market.

The average 30-year mortgage rate reached a three-year high of 7.4% earlier this month before easing slightly. According to Oxford Economics, higher mortgage rates have made home purchases unaffordable for an additional five million Americans since the beginning of the year, AP reported.

Further monetary tightening could increase borrowing costs for mortgages, auto loans and credit cards, adding to household financial pressures. The challenge for policymakers is to contain inflation without unnecessarily weakening consumer spending and economic activity.

Market forces had already pushed borrowing costs higher before the Fed's September rate increase, highlighting the broader financial conditions facing households and businesses.

Warsh's comments in focus for December rate decision

Investors will closely examine Warsh's news conference following Wednesday's policy announcement for signals about the Fed's next move.

Warsh is expected to reiterate the central bank's commitment to bringing inflation back to its 2% target in a more timely manner. Such language could reinforce market expectations of another rate increase at the Fed's December meeting, AP reported.

If policymakers leave rates unchanged, Warsh may also face questions about why the central bank raised rates in September but paused in October despite further evidence of accelerating inflation.

The Fed's decision will therefore be assessed not only for its immediate implications for borrowing costs but also for clues about the pace and extent of future monetary tightening.

Strong economic growth gives Fed room to manoeuvre

The US economy continues to show resilience despite elevated inflation and higher borrowing costs. Unemployment remains relatively low at 4.2%, although hiring has been sluggish.

According to a FactSet forecast cited by AP, US economic growth is expected to reach an annualised rate of 3% in the July-September quarter, accelerating from 2.2% in the April-June period. The government is scheduled to release its preliminary estimate of third-quarter gross domestic product on Thursday.

The combination of solid economic growth, a relatively stable labour market and persistent inflation complicates the Fed's policy choices. Holding rates steady could give policymakers more time to assess the effects of higher energy prices, while another increase could help restrain demand but add to pressure on households and businesses.

The Fed's meeting is part of a busy week for global central banks. The Bank of Canada is expected to raise its benchmark rate by 25 basis points to 2.5% on Wednesday, while the European Central Bank and the Bank of Japan are expected to leave their respective rates unchanged on Thursday, AP reported.

For the Fed, the immediate challenge remains determining whether the recent acceleration in inflation requires further action or whether policymakers can afford to wait for more evidence on the economic impact of the Iran war and higher energy costs.