The market believes that an interest rate cut in October is "set," but some Federal Reserve officials do not see it that way

The divergence between the Federal Reserve and the market is widening, with one side consisting of investors who believe that another rate cut in October is imperative, while the other side includes some Fed officials who remain vigilant about inflation and call for caution.

On Monday, several regional Fed presidents spoke out in quick succession, refuting the notion that "a rate cut next month is a done deal." They emphasized that even if policymakers need to balance between preventing excessive tightening and combating inflation, they should not rush into easing policies.

The core concern of these officials is persistently high inflation. Cleveland Fed President Beth Hammack stated in Frankfurt on Monday that inflation trends are moving in the "wrong direction." St. Louis Fed President Alberto Musalem also expressed a similar view, stating that policymakers need to "proceed with caution."

However, the market seems to be ignoring these hawkish warnings. According to trading data from federal funds futures, investors and Wall Street analysts remain convinced that easing policies are on the horizon. According to the CME FedWatch tool, about 90% of investors are betting that the Fed will cut rates by 25 basis points at the meeting on October 28-29, with 70% expecting another cut in December.

Inflation Concerns Become the Main Reason for Hawkish Statements

Data released last Friday showed that U.S. inflation remains stubbornly high. The overall PCE inflation rose 2.7% year-on-year in August, while core PCE inflation increased by 2.9%, both exceeding the Fed's 2% target.

Hawkish officials generally believe that any overly accommodative measures are premature until inflation clearly returns to the 2% target.

St. Louis Fed President Alberto Musalem stated on Monday that policymakers should "hold firm" against inflation that is above the target range.

Cleveland Fed President Beth Hammack's view is even sharper. She pointed out that the Fed has "failed its mission" for four and a half years because inflation has consistently been above the target. She noted that unlike the downward trend in inflation when rates were cut last year, "inflation has basically been flat over the past year, with some components even rising."

In her view, inflation will not return to the 2% target until the end of 2027, thus "a restrictive policy stance needs to be maintained."

Other officials have also expressed similar caution. Kansas City Fed President Jeff Schmid stated last week that inflation remains too high, and current policies are only "slightly restrictive." Chicago Fed President Austan Goolsbee warned against "prematurely implementing too many rate cuts" simply because of a slowdown in employment data.

Downside Risks to Employment Create Divergence

However, this cautious stance is not shared by all officials, and the divisions within the Fed are evident. In the latest economic forecasts, 10 officials expect three rate cuts this year, while 9 officials anticipate two cuts or fewer.

Officials perceived to be more inclined towards rate cuts primarily cite the increasingly evident signs of weakness in the labor market. New York Fed President John Williams stated on Monday that the Fed does not want to cause "unnecessary harm" to its mission of maximizing employment Federal Reserve Governor Michelle Bowman warned last Thursday that the Fed faces the risk of being "behind the curve" on employment issues, stating that the labor market remains "fragile." Newly appointed Governor Stephen Miran also indicated that the longer borrowing costs remain high, "the greater the risk that the economy will see a substantial rise in unemployment."

However, Richmond Fed President Tom Barkin believes that due to hiring constraints faced by businesses over the past few years, they are unlikely to resort to layoffs, which means "the downside potential for the labor market should be limited."

Economists at Citigroup released a report on Monday stating that the tone of Fed officials is "too hawkish." The bank believes that officials "overestimate the upside risks of inflation while underestimating the downside risks to employment—this may become more apparent in the coming months."

Before the meeting at the end of October, the Fed will receive the latest September inflation and employment data, which will be key decision-making factors. However, if the U.S. government falls into a shutdown, it could delay the release of key economic data, adding more uncertainty to the Fed's decision-making.