Strong GDP Keeps a December Fed Hike in Play

The Federal Reserve held its policy rate at 3.75% to 4.00% on October 28, but the decision did not signal that tightening is over. Governors Lisa Cook and Beth Hammack dissented because they preferred a quarter-point increase, and data released the next morning strengthened the case that economic activity can tolerate higher rates.

The Bureau of Economic Analysis estimated that real gross domestic product grew at a 3.4% annual rate in the third quarter, up from 2.2% in the second quarter. Investment, consumer spending and government spending all contributed. A narrower measure of private demand, real final sales to private domestic purchasers, increased 4.9%. That is stronger than the pre-release estimates discussed in the original report and removes some uncertainty about whether growth merely looked firm because of forecasting noise.

Inflation is more complicated. The third-quarter PCE price index increased at a 2.1% annual rate, and core PCE rose 2.5%, both slower than in the second quarter. September data tell a less comfortable story: headline PCE prices increased 0.5% from August and 3.6% from a year earlier, while core PCE rose 0.3% for the month and 3.1% over 12 months. Real consumer spending was essentially flat in September even as nominal spending rose 0.5%.

That combination explains the policy tension. Strong quarterly growth and robust investment reduce the immediate cost of another rate increase. At the same time, the monthly inflation data show that price pressure remains above the Fed's 2% objective. Some of that pressure comes from energy and tariffs, which interest rates cannot directly reverse. Higher borrowing costs can still restrain demand, housing and capital spending, but they are a blunt response to supply-driven inflation.

The Federal Open Market Committee's statement described economic activity as expanding at a strong pace, with resilient domestic spending, strong productivity and robust capital investment. It also said inflation remains elevated and emphasized that officials want more information before deciding the next step. The two dissents matter because they show that a hike already has support inside the committee, not merely in futures markets.

For equity investors, the risk is not that 3.4% GDP growth is inherently bad. It is that resilient growth gives the Fed room to keep real interest rates restrictive while inflation remains above target. Long-duration technology stocks are especially sensitive when Treasury yields rise because more of their valuation depends on profits expected far in the future. Equal-weighted and value-oriented exposures may react differently, but they are not insulated from slower credit creation.

The next decision should turn on whether October inflation and labor data confirm September's pressure. A single strong GDP release does not prove the economy is overheating, and the 2.5% quarterly core PCE rate shows some disinflation. The evidence now points to a genuine two-sided decision: growth is strong enough to permit a hike, while the composition and persistence of inflation will determine whether one is necessary.