- Key insight: The midterm elections are likely shaping market expectations about the Federal Open Market Committee's policy more than the decision itself. But the political implications are still consequential.
- Expert quote: "The Fed stresses very much its own independence and its political independence. They wouldn't want to be seen, for instance, raising rates and hurting the administration, the economy in general." — Dan North, senior economist for Allianz Trade Americas
The Federal Open Market Committee is broadly expected to keep interest rates unchanged despite signs that inflation is worsening.
More than 90% of federal funds futures contracts are pricing in no change to the benchmark rate after Wednesday's meeting, according to the CME Group's FedWatch tool, despite nearly 84% of the market anticipating at least one 25 basis point increase before the end of the year.
There are several dynamics driving this sentiment. Some economists question the effectiveness of the Fed's policy tools in the current environment. Others are simply following the latest guidance from FOMC participants — outdated as it might be.
Then there's the politics of it all.
Because of next week's midterm elections, which will decide the balance of power in Congress for the next two years, some analysts believe the Fed will be reluctant to deliver a surprise hike, lest it be seen as putting its thumb on the scale of public sentiment.
"We've got the midterms coming up next week, so that is a little bit of a delicate situation," said Dan North, senior economist for Allianz Trade Americas. "I think the Fed will take the position of doing nothing, because if they were to raise rates, that would raise questions about political favor, somehow, on the Federal Reserve. They want to avoid that."
President Donald Trump — who stands to lose his governing majority and face myriad congressional investigations into his administration should Democrats take one or both of the houses — is always ready to criticize the central bank for what he sees as partisan policy actions.
But North said the issue is not Trump-specific. He would expect the Fed to steer clear of the political fray under any administration. Not because a single rate hike would change the economic outlook dramatically in one week — such changes take months to take effect — but because of the optics.
"The Fed stresses very much its own independence and its political independence," North said. "They wouldn't want to be seen, for instance, raising rates and hurting the administration, the economy in general."
The historical record on FOMC activity ahead of midterm elections is thin and the results are mixed. Since 1954, the committee has convened in October or early November ahead of a midterm election 11 times, according to data on committee votes maintained by the Federal Reserve Bank of St. Louis. Those meetings have resulted in three rate hikes, four rate decreases and four instances of no change.
For all federal elections — including presidential cycles as well as midterms — the results are similar: the FOMC dropped rates 10 times, raised them six and held them steady nine. There were also 10 election cycles in which the Fed did not vote immediately before ballots were cast but instead, met in late September and again shortly after the election.
More recently, rate increases directly before federal elections have become increasingly rare. The committee has approved just one pre-election hike since 1980: a 75 basis point increase directly before the last set of midterms in 2022.
That jumbo rate hike was the fourth consecutive three-quarter-point increase by the FOMC, its sixth raise in as many meetings and part of an overall policy tightening campaign that saw the federal funds rate increase more than 5 percentage points in a single year. This is emblematic of other pre-election rate increases. Such moves have tended to be part of hiking cycles that span several consecutive meetings.
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In theory, the Fed could be at the beginning of such a cycle. The FOMC raised rates in September, most committee members expected to raise at least once more this year and the Fed's primary concern at the moment — persistently high inflation — appears to be
"All in all, economic data suggest that there is no good reason for the Fed to delay tightening monetary policy," said Jerry Tempelman, former senior analyst at the New York Fed and current vice president of economic and fixed income research at Mutual of America Capital Management.
But recent commentary from Fed officials suggests the current tightening campaign might move in fits and starts. In a speech earlier this month, Fed Vice Chair Philip Jefferson said he supported the hike last month as a way of shoring up the Fed's credibility, rather than an outright effort to crush inflation.
"This was an important step to ensure longer-term inflation expectations remain well anchored and to validate the public's confidence that we will achieve our 2% inflation objective in a timely manner," Jefferson said.
There is some evidence that market confidence has been restored. Yields for 10- and 30-year Treasuries have declined about 30 basis points each during the past month, a sign that investors expect the Fed to get inflation under control.
Jefferson said he would come into the meeting with an open mind about what to do next.
"My colleagues and I will need to come to our own judgment, which may take more time," he said. "I will continue to assess whether underlying trends suggest that inflation will return to target with sufficient speed."
New York Fed President John Williams, the vice chair of the FOMC, similarly said he was in no rush to hike again in October.
"With the policy action we took at our September meeting, there is no need for urgency, and we have time to gather more information," Williams said in a speech in late September.
The remarks from Jefferson and Williams have been cited by many analysts as evidence that the FOMC will stand pat in October. Fed Chair Kevin Warsh had a chance to refute their positions or steer public sentiment in a different direction during a
Warsh has said he wants markets making their own judgments rather than trying to simply anticipate the Fed's next move — even if this means investors making the wrong call. In an analyst note this week, Bank of America Securities U.S. economist Aditya Bhave said the meeting could be an opportunity for Warsh to prove how willing he is to surprise markets.
The fact that there is any ambiguity heading into the meeting, Bhave said, demonstrates how much things have changed under the new Fed chair.
"Under [former chairs Jerome] Powell or [Janet] Yellen, there would be basically zero chance that the Fed would risk a market disruption by delivering such a large hawkish surprise," he wrote. "That too, just six days before the midterms."
Politics aside, John Velis, Americas macro strategist at BNY, said there is a strong fundamental case for keeping rates unchanged. While inflation is high and persistent, he said, it is largely being driven by a pair of shocks that are not easily addressed by tighter monetary policy.
On the supply side of the economy, high oil prices as a result of the Iran war are driving up costs of food, energy and key index components like airfare. Velis said higher borrowing costs would not defray these costs. On the demand side, the build out of artificial intelligence capabilities is driving up the cost of chips and other inputs — a trend that a rate hike could curb, but not without inflicting harm on other parts of the economy.
"I'm not sure that interest rate policy, unless you absolutely crush the economy and the credit asset class, that you're going to actually see that inflation coming down," he said. "That's structural as well."
In terms of the midterms, Velis said it is unlikely that the political considerations will alter the outcome of the meeting, but he does believe they have played a role in shaping expectations heading into it.
"I've looked at the historical records and it does happen that there are rate changes in October. I don't think the midterms would necessarily sway most of the orthodox members of the committee to hold off or hike simply because the midterms are a week after," he said. "I wouldn't put a lot of stock in that, but the market might. That may be what the market is thinking."
