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Originally published at Ed Dowd: Beyond the Narrative.

The FOMC announces at 2 p.m. Eastern today. Consensus is a hold. Prediction markets and futures put the odds of a 25 basis point (bp) hike around 7-9%, with the bulk of the probability shifted to December. Some participants are layering in a political filter: midterms are days away, so the Committee may prefer to stay quiet this week and wait until after the election to move. That is the narrative. The 3-month T-bill tells a slightly different story.

For subscribers who have followed the prior notes on this, the simple method remains the same. Historically the Fed follows the front end of the Treasury market more than the reverse. The 3-month T-bill is the cleanest real-time read. Current Fed funds target is 3.75–4.00%. The current midpoint is 3.875%. A 25 bp hike would take the midpoint to roughly 4.125%. The secondary market 3-month T-bill has been trading in a zone that is at or above that 4.125% threshold for stretches of the recent period since the last hike. When the 3-month T-bill sits above the midpoint of the current range plus the next step, the model has historically pointed to a minimum 25 bp move. The current difference as of yesterday evening was 28.5 bp.

In September, the Committee followed the 3-month T-bill and raised 25 bp into what I argued was a supply shock, not a classic demand overheating. Energy and commodity pressures, geopolitical disruptions, and the inability of the policy rate to produce more oil or clear shipping bottlenecks were treated as if they were the same problem as excess demand. Labor data that has been lagging, revised, and compositionally misleading (healthcare gains masking weakness elsewhere) was used to justify the move. Credit markets then delivered a relatively quick reaction. I wrote at the time that this looked like the start of a policy error and that the Committee would likely have to reverse course. Nothing fundamental has changed on the supply side since then. Hiking again would be compounding the same error.

That is why I do not think they should hike today. Rate policy cannot fix a supply constraint. It can only crush demand further at a time when housing is already rolling over, the AI complex is crowded and leveraged, private credit is showing stress, and the real economy is softer than the headline numbers admit. Another 25 bp now simply accelerates the feedback loop that credit markets already started signaling after September.

However, If the Committee is still using the market as the primary input rather than the political calendar, the odds are closer to 50/50 IMHO than the 9% priced in. Most market participants would be shocked by a hike this afternoon. Equity and credit markets are not positioned for it. A surprise 25 bp would likely produce an immediate bout of volatility, wider credit spreads, pressure on risk assets, and a scramble to reprice the path. That volatility would not be the end of the story. My guess is that longer-term government yields would drop further and sooner than most expect if they hike as future economic growth projections become tempered quickly. Such a move would exacerbate an already ongoing policy error. The bond market would price in a faster arrival of the demand destruction and the eventual policy reversal, not a durable higher terminal rate. Maybe that is what the Fed wants…bring long end yields down by hiking into a supply shock and crushing growth?

In the event of a hold decision I expect Fed Chair Warsh to deliver very hawkish commentary that may move the December rate hike expectations into November based on the current 3-month T-bill yield market signal. A more hawkish press briefing would also not be well received by markets.

Kevin Warsh is the wildcard here. He has spent his early tenure dialing back forward guidance, declining to submit his own dots, and emphasizing that the Committee should not over-share future intentions. He has hawkish leanings on inflation and has framed the current environment as one where the Fed still has work to do on price stability. As a new chair he is also establishing credibility. A quieter Fed that lets markets do more of the pricing can cut both ways: it reduces the political theater of explicit guidance, but it also leaves more room for the Committee to follow the actual market when the market is pointing up on the short end. Whether Warsh wants to demonstrate that the Fed is data-dependent and market-aware, or whether he prefers to avoid injecting monetary policy into the final stretch before midterms, is not knowable from the outside. That is the point of removing the guidance.

Bottom Line

They should not hike into a supply shock. The simple 3-month T-bill framework says the market has already priced in a higher front-end rate, and the Fed has a history of following that signal. The priced in probability is low because of the political calendar and the expectation of a December move. If they decide to follow the market instead of the political calendar and hike, the shock would be real in risk assets and credit, while longer end US Treasury yields would likely fall faster than consensus expects as the policy error is compounded. If they do not surprise with a rate hike then I am expecting very hawkish commentary in the press briefing from Warsh.

I believe 50/50 odds are more appropriate for this rate hike decision and if they do surprise you will know why. We will all know at 2 p.m.

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