How can the Federal Reserve's policy stance withstand market scrutiny? The latest economic data provides the answer.

A recent set of US economic data has thoroughly overturned some politicians’ radical claims about Federal Reserve policies. Q3 GDP grew at an annualized rate of 4.3%, far exceeding expectations; inflation rose from 2.1% in spring to 2.8%. Behind these figures lies a deeper policy debate—about how the Federal Reserve should adjust short-term interest rates.

Over the past year, heated debates have centered around Fed Chair Powell’s interest rate decisions. Critics argued that the Fed should significantly cut short-term rates, which were targeted at 4.25% to 4.5%, with some even advocating for reductions to 1% or lower. But what is the reality? Under a high-rate environment, the US economy has shown remarkable resilience.

Contradictory Signals Between Economic Resilience and Inflation Expectations

What would happen if short-term rates were sharply lowered? The economy might receive a short-term boost, but inflationary pressures would follow. Over the past year, the Consumer Price Index increased by 2.7%, still above the Fed’s long-term target of 2%. The latest analysis from the Cleveland Fed indicates that the current annualized inflation rate has risen back above 3%.

Here lies a key point market participants must understand: short-term rates and long-term rates are not the same. The federal funds rate is the price for overnight funds, mainly affecting savings accounts, credit cards, and auto loans—short-term borrowing costs. But mortgage rates, corporate financing, and government bond yields are priced independently in the bond market, heavily dependent on market expectations of future inflation.

The Fed lowering interest rates itself cannot directly reduce long-term rates. If markets worry that excessive easing will lead to overheating and rising inflation, long-term rates may actually increase. This is precisely what happened in 2024—after the Fed started cutting rates, the 10-year US Treasury yield did not decline but instead rose from around 4.1% at the start of the year to recent levels of 4.19%, higher than before the rate cuts.

Inflation Anxiety Reflected in Gold and Silver Prices

Market concerns about inflation expectations are most evident in precious metals prices. Since January, gold has surged over 70%, reaching record highs; silver has doubled in value. This is not technical trading hype but a genuine reflection of market fears about long-term purchasing power erosion.

Implied inflation expectations in the bond market are also rising. In July, five-year inflation expectations briefly climbed to 2.5%. This indicates that professional investors’ confidence in future price stability is waning.

Policy Risks and Checks in 2026

Next year, the situation will change. Powell’s term as Fed Chair will end in May, and the new leadership’s policy stance may lean more toward easing. This is a variable the market must watch closely.

However, there are also some balancing forces. Recent polls show declining support for the current government’s economic policies. There is a growing awareness of checks and balances within Congress. Earlier plans to replace independent statistical officials were ultimately abandoned, reflecting that institutional checks still exist.

Currently, the Fed’s independence remains intact, and economic data have validated the reasonableness of the current policy framework. But future policy space may be more influenced by politics. For market participants, it is crucial to closely monitor leadership changes at the Fed and potential shifts in policy.

The current economic performance and inflation pressures warn us: aggressive short-term interest rate policies do not necessarily lead to better economic outcomes and may instead incur long-term costs. A prudent Fed policy framework, at least for now, has been validated by market realities.