Inflation Risks Still Outweigh Labor Market Risks

All eyes are on Wednesday’s FOMC meeting. Markets expect the Fed's monetary policy committee to leave the federal funds rate (FFR) unchanged at 3.50%-3.75%, with the CME FedWatch assigning roughly a 70% probability to no change and a 30% probability to a 25bps rate hike. Investors will be closely watching the FOMC statement, Fed Chair Kevin Warsh's press conference, and the degree of any dissent for clues about the policy outlook. Given the economy’s continued resilience and persistent inflation pressures, there is a reasonable chance that two hawkish regional Fed bank presidents, Lorie Logan and Beth Hammack, dissent in favor of a rate hike.

Recent data continue to suggest that inflation risks outweigh labor market risks. Consumer spending remains robust, the labor market is balanced, and manufacturing activity is rebounding, boosted by the AI investment boom and onshoring. As a result, the FFR futures market continues to price roughly two 25bps rate hikes over the next 6-12 months (chart).