Fed Pauses, Markets Expect Hikes: Will Tighter Policy Reduce Inflation?

As I expected and discussed in a previous post, the Federal Reserve announced on October 28, 2026, that it would maintain its policy rate unchanged. Specifically, in a 10 – 2 vote:

“The Committee decided to maintain the target range for the federal funds rate at 3-3/4 to 4 percent, in support of the Federal Reserve's dual mandate. The Committee is continuing its policy of maintaining ample reserves in the banking system.” 

The next Federal Open Market Committee (FOMC) meeting is scheduled for December 9, 2026. According to market-implied probabilities from the CME FedWatch tool as of October 28, 2026, investors assign roughly a 79% probability that the FOMC will raise its policy rate by 25 basis points at its December meeting.

       

Looking ahead to the January 2027 meeting, investors appear to assign roughly even odds to an additional 25 basis point increase. Current pricing also suggests expectations that rates may remain near that level for much of 2027.

 

Conclusion

The financial markets expect the policy rate set by the FOMC to increase 50 basis points (half of a percent) in the next 3 to 6 months. Whether those rate increases will help 'ensure a timely return of inflation to the Committee's 2 percent goal' remains an open question. My view is that policy rate increases will not help because the elevated inflation we are seeing now has to do fundamentally with a supply shock in energy prices. While those pressures may spread into other sectors of the economy, higher policy rates cannot create the additional energy supply the market demands.

What the Fed's decision does introduce is the risk of a policy error. If inflation is primarily supply-driven, further tightening could unnecessarily weaken economic activity while doing little to address the underlying cause of inflation. In that scenario, policymakers may inadvertently contribute to the very economic slowdown they are attempting to avoid.

Indeed, an argument can be made that the Fed's concern is not necessarily the first-round impact of higher energy prices. Rather, their concern is that households and businesses adjust their expectations, wages, and pricing behavior in response, causing inflation to become embedded throughout the economy. In that case, one could argue that rate hikes may not increase energy supply, but they could still help contain broader inflationary pressures. While that is an excellent point, we must remember the mechanism through which such an outcome would likely occur: slower economic growth. In that sense, the effort to contain inflation may itself contribute to the economic weakness policymakers hope to avoid.