Federal Reserve Expected to Hold Rates at 4% Amid 3.7% Inflation

The annual inflation rate reached 3.7% in September, a figure that has set the stage for the Federal Reserve to leave interest rates unchanged at its October meeting. This pause would follow a 25 basis point increase to a range of 3.75% to 4% in September, which marked the bank's first rate hike since 2023. Market data from the CME Group's FedWatch tool indicates that fed funds futures price in less than a 10% chance of another quarter point increase this week. Nearly 75% of market participants expect at least one additional hike by year-end.

Higher energy costs are complicating the economic outlook, with Brent crude oil trading at a five-month high on Friday before dipping slightly. These surging oil prices contributed to an increase in the September producer price index. Heather Long, chief economist at Navy Federal Credit Union, stated that inflation remains the primary issue in the U.S. economy and appears to be becoming more broad-based. She noted that for consumers, this implies high borrowing costs for the foreseeable future, though she added that the Fed is unlikely to hike rates in October due to the proximity of the election.

The timing of the meeting, just days before the midterm elections, adds a layer of political scrutiny to the central bank's decision. Mark Shore, director and economist at CME Group, observed that in previous election cycles, the Fed has generally maintained its established course. The four instances where the Fed raised rates near a midterm election, occurring in 1978, 1982, 2018, and 2022, were all driven by rising inflation. Aditya Bhave, an economist at Bank of America, wrote in a research note on Oct. 23 that if the Fed holds rates steady, markets may question the institution's credibility in fighting inflation.

The benchmark rate set by the Fed directly influences what banks charge for overnight loans, which in turn affects consumer borrowing and savings rates. While higher rates can ease inflationary pressure, they simultaneously increase the cost of borrowing, adding to the financial strain on households. Mark Zandi, chief economist at Moody's, explained that higher longer-term rates are causing more damage to consumer budgets than short-term rates. These longer-term increases are weighing on refinancing activity, homebuying, and vehicle sales, while short-term hikes primarily raise costs for credit cards, consumer finance loans, and home equity lines.

Most credit cards carry variable rates that track the Fed's benchmark closely, meaning current average rates of 23.96% on new offers, as reported by LendingTree, are likely to remain stable if the Fed holds. Mortgage rates, which are influenced more by Treasury yields and economic outlook, are currently hovering near 7.4% for 30-year fixed loans. This level aligns with the 10-year U.S. Treasury yield, which has been trading near 5%. Auto loan financing costs remain elevated, prompting many buyers to take on larger loans and extend repayment terms to manage affordability, according to Edmunds.

Federal student loan rates for new borrowers are already higher for the current academic year, based on results from the May auction of the 10-year Treasury note. Savings rates tend to follow changes in the federal funds rate, providing a benefit to savers who continue to earn attractive yields on high-yield savings accounts and other deposit products due to the Fed's decision to keep rates elevated.