At its September meeting, the U.S. Federal Reserve (Fed), as expected, left its federal funds target rate unchanged, at 5.25%–5.50%. The outlook remains hawkish, though, and the interest rate market currently is pricing a 30% probability of an additional 25-basis-point (bp; 100 bps equal 1.00%) hike at the Fed’s November meeting. Despite core inflation’s continued slowing, its current 4.3% year-over-year pace seems too high to us to expect interest rate cuts anytime soon.

Demand has stayed robust, and higher-frequency growth indicators point to reacceleration ahead in the third quarter. The good news is that consumer-driven inflation expectations have decreased and higher-frequency inflation indicators point to inflation stabilization despite the recent rise in energy prices.

The Fed also needs to carefully calibrate between higher rates and supply. A tightening of financial conditions through higher rates will likely affect supply negatively, which would worsen the growth-versus-inflation trade-off. Wage gains have cooled lately as strong economic growth has boosted the workforce participation rate, leading to fewer job shortages. In our view, the best outcome for asset markets is for the Fed to speak hawkishly but keep real rates stable. The incoming data on demand versus supply and inflation will be crucial for the Fed to assess whether further tightening is required.

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