Fed Keeps Rates Unchanged Amid Rising Inflation Concerns

Federal Reserve Governor Chris Waller recently stated that the Fed will continue to let inflation run hot, but this approach is not without controversy. In a recent meeting, the Fed kept interest rates unchanged in a 9-3 vote, with three dissents showing that the committee is not united behind this stance.

The markets had priced in a 30%-40% chance of a hike, creating a significant gap between expectations and the decision. Historically, the Fed has raised rates only when the pre-meeting probability was at least 60%. However, despite the optimism expressed by Chair Kevin Warsh about an economy expanding at a solid pace, real GDP grew at a measly 1.5% annualized pace in Q2.

The Fed's preferred inflation gauge, the core Personal Consumption Expenditures Index (PCE), rose just 0.1% in June, but much of the softness came from idiosyncratic price declines that are unlikely to persist. The share of items with inflation above 3% has worsened again since April 2025, and Warsh's comments at the press conference suggested a dovish bias.

Warsh downplayed AI-related price pressures, attributed recent market rate increases to economic strength rather than Fed expectations, and implied that higher market rates could substitute for a Fed hike. He also mentioned a possible shift towards using a broader set of inflation measures instead of PCE, which would further obfuscate the framework.

The post-meeting bond moves suggest that markets are responding to the Fed's willingness to tolerate a hotter economy and more inflation in the near term. This is implicit forward guidance, and markets cannot ignore the Fed because expectations for policy are central to Treasury pricing.