Fed Officials Debate Whether They Have Raised Rates Enough

Officials, whose two-day policy meeting concludes Wednesday, could raise rates again in December or next year if the economy doesn’t cool as they expect and inflation picks up again after slowing since June.

They also will likely consider whether the recent swift run-up in Treasury yields could effectively substitute for another rate increase.

The central bank releases its policy statement Wednesday at 2 p.m. Eastern time. Fed Chair Jerome Powell will answer questions from reporters at 2:30 p.m. Here’s what to watch for:

Wait and see, but for how long?

The Fed’s anticipated decision would mark the second consecutive meeting in which it hasn’t raised rates, underscoring its wait-and-see stance in the inflation fight. Officials have raised rates since March 2022 at the fastest pace in four decades. Their most recent increase, in July, brought the benchmark federal-funds rate to a range between 5.25% and 5.5%.

The big questions for the Fed on Wednesday are likely to be addressed in Powell’s news conference. One will center on what officials want to see. He’s likely to say they hope for continued slowdown in inflation and signs that economic activity and hiring are cooling after brisk growth during the July-through-September period.

Another will be what it would take for officials to conclude they are moving in the right or wrong direction: The former would allow officials to hold rates steady at coming meetings, while the latter could lead them to hike again.

Growth climbs as inflation cools

Inflation has slowed notably since June, although consumer spending and hiring have revved up, creating a puzzle for Fed officials. Normally, inflation eases as economic activity weakens.

This leaves officials uncertain how the economy and inflation will unfold from here. Continued economic vigor would fuel concern that inflation won’t keep slowing without tighter policy. Softening growth would give them confidence that price pressures will keep waning without further rate increases

Core inflation, which excludes volatile food and energy prices and which peaked at 7% last year, hit a 2.8% annualized rate over the April-to-September period, according to the Commerce Department.

That is a striking slowdown in inflation and the Fed has raised rates by 5 percentage points, said Dean Maki, chief economist at hedge fund Point72 Asset Management. “It’s a reasonable strategy for them to keep rates on hold for a while and see how things proceed."

Financial conditions tighten

Powell suggested in remarks on Oct. 19 that the run-up in long-term Treasury yields over the past three months could potentially substitute for Fed rate increases if yields are rising for reasons that don’t reflect market expectations of a steeper Fed rate path. The bond market selloff has pushed the 30-year fixed-rate mortgage close to 8% for the first time since 2000.

Powell is likely to face more questions on Wednesday over how staff economists and policy makers are evaluating the potential economic effects of the rise in borrowing costs.

Yields have been climbing as some investors look with concern at rising Treasury issuance at a time when several sources of demand for longer-dated securities, including domestic banks, foreign buyers and the Fed itself, have retreated.

Even though the Fed isn’t responsible for the recent run-up in rates, “I do think it’s something that monetary policy has to take into account," said Eric Rosengren, former president of the Boston Fed. Financial conditions have tightened as Fed officials wanted, it just hasn’t happened because of Fed policy, he said.

A December rate hike?

Investors will be listening for any signals Powell offers about a potential December rate rise. In September, most officials projected one more increase would be warranted this year, but some officials have been speaking in recent weeks as if they aren’t eager to raise rates again unless hotter-than-expected economic data force them to. That is a change from a year ago, when they were more concerned about tightening too little.

Still, it is in the Fed’s interest to keep a rate hike as a possibility “because the minute they completely rule that out, the next question is going to be, ‘When are the rate cuts coming?’" said Maki.

Richard Clarida, who was Fed vice chair from 2018 until early 2022, said he thinks the central bank will ultimately want to err on the side of raising rates in December as insurance against the risk that growth and inflation move down too sluggishly. “I lean in the direction that they are going to get this hike in," he said.

Rosengren disagreed and said the Fed won’t need to raise rates again as long as inflation gauges continue to notch milder readings. “I don’t see from the inflation and wage data a reason to make policy more restrictive as long as those continue to show progress," he said.

The policy statement

Fed officials won’t release new economic projections at this meeting, leaving their policy statement as the most concrete form of guidance reflecting the consensus of the rate-setting committee. Officials aren’t expected to change the language that they have maintained since May, highlighting the prospect of still-higher rates.

They are likely to note how the economy and hiring strengthened in recent months. Some analysts think the Fed should also signal growing attention to the swift rise in long-term Treasury yields in the statement.

“To get the balance right in the statement, I think you need to mention both" stronger activity and the tightening in financial conditions, said William English, a former senior Fed economist who is a professor at Yale School of Management.

Others see little reason for the Fed to call out the recent run-up in market-driven borrowing costs, in part because introducing new language into the heavily scrutinized policy statement can create complications later down the road.

“You really do have to think about the off-ramp for that," said Clarida. It would be easier for officials to have Powell simply discuss changes in the financial outlook during his news conference, he said.

Write to Nick Timiraos at Nick.Timiraos@wsj.com