With persistent inflation and Middle East energy turmoil, the Federal Reserve's monetary policy in the fourth quarter has reached a delicate juncture. On one hand, persistently high prices are fueling calls for further interest rate hikes; on the other hand, rising credit costs are revealing signs of economic fragility, compounded by the timing of the midterm elections, forcing the Fed to slow its pace and adopt a wait-and-see approach. The market and mainstream economists have largely formed a consensus expectation: a pause in rate hikes in October is highly probable, while retaining the option of further increases in December. This policy maneuvering will continue to influence asset pricing.

The September interest rate hike has been implemented, increasing residents' credit costs.

On September 16, the Federal Reserve raised interest rates for the first time in more than three years, unanimously increasing the federal funds rate by 25 basis points to a target range of 3.75%-4.00%. This tightening policy quickly transmitted to consumer credit, with credit card, home equity, and variable-rate mortgage rates all rising simultaneously, significantly increasing repayment pressure on borrowers.

Key takeaways from the meeting: Walsh's communication dilemma – what wasn't said was more crucial.

The market widely expects the FOMC to keep interest rates unchanged this week. The focus of this meeting is not on the rate decision itself, but on the statements of Federal Reserve Chairman Warsh. He faces a dilemma: reiterating the Fed's determination to combat inflation while rationally explaining the decision to postpone rate hikes. This scenario is quite similar to the July meeting, where keeping rates unchanged was in line with expectations, but investors were dissatisfied with Warsh's reluctance to signal further rate hikes. Stephen Stanley, chief economist at Santander U.S. Capital Markets, commented: "I expect rates to remain unchanged, but I do think they will raise rates again in December. The tricky part of this meeting's communication is that Warsh needs to explain why no action was taken in October, and also why a rate hike in December is still possible." Traders should note that what Warsh omits can sometimes be the most crucial signal. The absence of hawkish rhetoric, or avoidance of commentary on long-term bond yields or oil prices, can all imply policy inclinations and are more likely to trigger a repricing of expectations than a direct statement.

The prevailing market view is that interest rate hikes will be postponed in October to avoid the sensitive election window.

Major economists, including Moody's Analytics chief economist Mark Zandi and KPMG chief economist Diane Swonk, have reached similar conclusions: the Federal Reserve is highly likely to hold rates steady at its October meeting. On the one hand, the Fed needs time to digest and observe the lagged effects of the September rate hike on the real economy; on the other hand, the meeting is close to the midterm elections, and the Fed will try to avoid implementing tightening policies during the election window to reduce unnecessary political interpretations. In short, October leans towards "skipping a rate hike," but the option of a rate hike in December remains open.

Inflationary risks stem from oil prices, while underlying weaknesses exist in the economic fundamentals.

The core driver supporting further interest rate hikes at the end of the year is the energy risk brought about by geopolitical conflicts in the Middle East. Escalating tensions in Iran are pushing up crude oil and diesel prices, and transportation costs will continue to be passed on to consumers, making it difficult for inflationary stickiness to dissipate quickly. However, the economy is not simply strengthening in one direction: the job market is weakening, hiring is cooling, wage growth has lagged behind inflation, and residents' real purchasing power is being eroded. The direction of the geopolitical conflict and the duration of high oil prices are highly uncertain, making the Fed's policy path highly uncertain. The tightening approach has shifted to a more cautious one, a clear distinction from the aggressive cycle of 2022. The pace of this tightening is drastically different from the continuous aggressive rate hikes of 2022. The Fed views the "pause for observation" as a risk management tool, not an abandonment of the fight against inflation. Swonk analysis suggests that the temporary pause after the rate hikes allows policymakers to investigate potential vulnerabilities within the economy and financial markets. The core policy objective is to suppress prices while preventing high borrowing costs and high long-term bond yields from triggering deeper downward pressure. Fed Governor Barr also mentioned that further policy adjustments are likely to be needed, but the pace is uncertain. If oil prices and inflation fall significantly early next year, the December interest rate hike may mark the end of this round of tightening.

Trading Mapping: Expectations of Fluctuations Dominate Dollar and Gold Price Movements

This policy theme will be the core anchor for the dollar and gold market in the fourth quarter. If the October meeting releases dovish signals, weakening expectations of a December rate hike, US Treasury yields will decline, putting pressure on the dollar, and gold is expected to recover. Conversely, if officials continue to maintain the possibility of a December rate hike, real interest rate expectations will remain high, supporting the dollar, while gold, with its non-interest-bearing nature, will continue to be suppressed by opportunity costs. The back-and-forth battle over rate hike expectations in the fourth quarter will continue to drive the cyclical price movements of the dollar and gold.