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Fed holds rates unchanged amid low inflation, financial tumult

Following the conclusion of a closely watched meeting, the Federal Reserve is keeping interest rates at record lows, citing a weak global economy, low inflation and instability in financial markets.

"Recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term," the FOMC said in a statement released at the conclusion of its latest two-day meeting.

In a press conference following the statement's release, Fed Chair Janet Yellen said "the situation abroad bears close watching," an acknowledgement of the recent flare up of volatility in global markets, such as in China.

There has been debate recently over how closely the Fed is watching foreign developments, particularly after Vice Chairman Stanley Fischer in August said, "the Fed's statutory objectives are defined in terms of economic goals for the economy of the United States, but I believe that by meeting those objectives, and so maintaining a stable and strong macroeconomic environment at home, we will be best serving the global economy as well."

Betsey Stevenson, a former Chief Economist at the Labor Department who is now at the University of Michigan, tweeted that she believes the Fed made the right call.

The Fed noted that the U.S. economy continues to expand at a moderate pace and that inflation expectations have been muted. It said the housing sector has shown further improvement. It also noted improvedments in the labor market saying "on balance, labor market indicators show that underutilization of labor resources has diminished since early this year."

U.S. Treasury bonds rallied after the Fed announcement. The 2-year yield was the standout, plunging 11%, or 0.089 percentage point, to 0.722%. Bond yields move in the opposite direction of prices.

Meanwhile, U.S. markets fluctuated after the news, with financial stocks taking a hit. And futures traders are pricing in a 28% probability that the Fed could hike rates next month and a 60% likelihood that the Fed will wait until Januarty to increase interest rates from the zero bound they have hovered at since 2008, according to Bloomberg.

The Fed on Thursday also upgraded its median GDP projections for 2015 but lowered estimates for 2016 and 2017. The Fed now is expecting median GDP growth of 2.1% for 2015, 2.3% for 2016 and 2.2%in 2017. It is expecting unemployment to decline to 4.8% by 2016, slightly lower than it had projected in June. 

The Fed's median projection for core PCE inflation of 1.4% this year, rising to 2.0 by 2018.

Inflation measures
Inflation measures

The Fed's latest dot plot also showed a surprise: that one committee member is expecting the key federal funds rate to turn negative.

Some believe the Fed is being a bit too optimistic.

The lone dissent to Thursday's decision was from Richmond Federal Reserve President Jeffrey Lacker, a hawk, who would have preferred for the Fed to increase rates by 25 basis points.

Yahoo Finance Editor Adam Samson contributed to this report.