When the Federal Reserve announces its latest policy decision on Wednesday, Wall Street expects the central bank will hold rates steady while retaining the option to further raise rates if needed.

"[Fed Chair Jerome] Powell wants to play it right down the middle," said Wilmer Stith, bond portfolio manager for Wilmington Trust. "They're well into their tightening cycle, if not done already."

In September, the Fed held interest rates steady in a range of 5.25%-5.50%, the highest in 22 years, while its updated forecasts released at the same time suggested one additional rate hike would be needed this year to bring inflation back to its 2% target.

Read more: What the Fed rate-hike pause means for bank accounts, CDs, loans, and credit cards

Powell signaled in a speech at the Economic Club of New York earlier this month the central bank could hold rates steady at its next policy meeting. The Fed chair also warned, however, that inflation was still too high and more interest rate increases are still possible if the economy stays surprisingly hot.

"Given the uncertainties and risks, and how far we have come, the Committee is proceeding carefully," Powell said.

"We will make decisions about the extent of additional policy firming and how long policy will remain restrictive based on the totality of the incoming data, the evolving outlook, and the balance of risks."

James Fishback, founder and chief investment officer at hedge fund Azoria Partners, said he thinks the Fed is on hold through the end of the year.

"We need a sustained period of below-target growth to bring inflation sustainably back to target," said Fishback, who once worked for hedge fund manager David Einhorn. "And there's no indication that that below-trend growth is coming any time soon."

Fishback added he wouldn’t be surprised to see the Fed hiking again in the first quarter of 2024 and keeping rates at or above current levels for close to two years.

The Fed's forecasts published in September suggested policymakers see interest rates coming down by 0.50% next year.

Stith also sees the Fed done for 2023, pointing to language Powell used in recent comments that said the central bank "could" — rather than "would" — when describing additional rate hikes.  

"That definitely solidifies that we're in the sort of terminal rate for this year," said Stith.

Whether it stays that way in 2024 "depends on what happens to this recent bout of economic growth," Stith added.

Last week, the first estimate of third quarter GDP showed growth clocked in at a whopping 4.9% annualized rate over the summer months, driven in large part by strong consumer spending, punctuated by a surge in retail sales in September.

The readings are stronger than officials would have thought at this stage in the rate-hiking cycle, raising the prospect that if the economy stays hot it could make it harder or take longer to lower inflation. The Fed's preferred inflation gauge — "core" PCE — showed prices rose 0.3% over the prior month in September, the most in four months, while annual price increases slowed modestly to 3.7% from 3.8% in August.

"The recent string of positive economic surprises will keep the Federal Reserve on high inflation alert, but it won't tilt the Federal Open Market Committee toward another rate hike at the November meeting," said EY chief economist Gregory Daco. "Still, Fed Chair Powell will undoubtedly want to maintain the optionality of a further rate hike in December or January, if needed."

Many economists, however, don’t believe the strength of the third quarter will continue.

Luke Tilley, chief economist at Wilmington Trust, says he doesn't think third quarter GDP is reflective of real strength in the economy.

"There's some seasonality with GDP," said Tilley. Other economic indicators, he said, point to "an economy that is slowing, and when that becomes clear, and you also have the inflation numbers, then the Fed has done hiking."

Market challenges emerge

Another challenge for the Fed to address this week will be the surge in long-term bond yields in the weeks since its September policy meeting.

The yield on 10-year Treasury notes has touched 5% in recent weeks, the highest level since 2007, while 30-year yields have traded north of 5% for much of October, also the highest in 16 years.

The bond rout has been attributed in part to the anticipation of stronger growth and stubborn inflation, which could see the Fed needing to hold rates higher for a longer period of time.

Powell has said that the central bank is closely watching a recent surge in long-term bond yields, while other Fed officials have said recently that if long-term interest rates remain elevated there may be less need for the Fed to act.

A 'Lemonhead problem'

Azoria's Fishback sees the Fed facing what he calls a "Lemonhead problem" — yes, a reference to the candy.

He likened the current rate-hiking cycle to the experience of sucking on the hard candy, which is sour at first, then turns sweet, only to turn back to sour again.

Fishback argued consumers and large companies are mostly immune to the Fed's rate increases, with lots of homeowners and companies having already locked in their borrowing at lower rates negotiated during the height of the pandemic. And now, consumers and businesses are getting 4%-5% on money parked in money-market funds or high-yield savings accounts, helping to fuel spending.

Read more: The best high-yield savings account rates for November 2023

"It's so much harder [this cycle] for the Fed to actually tighten policy because they're working through financial conditions," said Fishback. "If companies are not inclined or not seeing higher interest costs, then nothing is actually changing."

Fishback sees the economy headed for a "no landing scenario" in which inflation doesn't actually cool while economic growth continues, even as interest rates remain elevated amid the Fed's attempts to bring down prices.

Tilley, chief economist at Wilmington Trust, said he thinks the economy is more likely to have either a soft landing — avoiding a recession while inflation returns to target — or a mild recession than face a no-landing scenario.

“We've got slower job growth, slower wage growth, and if an economy has slowing job growth, slowing wage growth, and businesses are facing 5% interest rates, what is the prospect of a reacceleration? It's not very high to me," Tilley said.

As a result, Tilley sees the Fed cutting rates by more than 50 basis points forecasted by the central bank in 2024.

"I think inflation and other numbers are pointing towards more like 100 basis points next year," Tilley said.

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