U.S. inflation heated up again in August, putting increasing rate-hike pressure on Federal Reserve Chairman Warsh at next week’s monetary policy meeting. Data released by the Bureau of Labor Statistics on Friday showed that core CPI, excluding food and energy prices, rose 0.3% month over month, a larger increase than expected, while core CPI rose 2.4% year over year, the lowest level in five and a half years. After the data was released, market bets on a Fed rate hike in September quickly intensified, with the probability of a hike soaring from about 70% on Thursday to more than 85%, and some economists who had previously expected the Fed to hold steady also began shifting toward forecasting a hike.
Omair Sharif, founder of Inflation Insights, said bluntly that the Fed has reached a point where it must prove its determination to fight inflation through action. Federal funds futures showed that investors raised the probability of a Fed rate hike at its September 15-16 meeting to more than 85% and expected another possible hike by December. Institutions including TD Bank and JPMorgan adjusted their forecasts after the data was released, shifting to expect a rate increase next week. Diane Swonk, chief economist at KPMG, said the focus of policy discussion has shifted from “whether a rate hike is needed” to “how much rates need to rise to control inflation.”
Warsh’s previous hawkish remarks drew more attention to next week’s meeting. He said on August 28 in Jackson Hole that underlying inflation in the United States had not shown meaningful improvement, and that if future data did not prove inflation was returning to the 2% target, policymakers would still have “work to do.” Sharif argued that after making such remarks, it would be difficult for Warsh not to support a rate hike. Anna Wong and Andrew Sacher of Bloomberg Economics also pointed out that if the Fed ultimately did not raise rates, Warsh’s credibility in the eyes of market participants could be damaged.
The forces within the Fed supporting tighter policy had already begun to increase. Although the benchmark rate was left unchanged at five consecutive meetings this year, three officials voted in favor of a 25-basis-point hike at the July meeting. Krishna Guha and others at Evercore ISI said that, with oil prices adding further inflationary pressure, a rate hike would also help preserve Warsh’s policy credibility, which had previously been affected.
Nick Timiraos wrote that investors have largely concluded that the Fed will raise rates next week for the first time in three years, and the harder question is what happens afterward. Since almost no one within the Fed believes that a single 25-basis-point hike is enough to suppress inflation, once a hike is decided next week, the signal conveyed is that the current level of interest rates was already off course. The market currently expects the Fed to raise rates at least three times in total by June next year, higher than the previously expected two times.
Former Fed Vice Chairman Richard Clarida made clear that if rates are raised next week, it will certainly not be a “one-and-done” move. Warsh himself is skeptical of “fine-tuning,” which also provides supporting evidence for the market. Piper Sandler strategist Kurt Lewis said that once the decision is made to tighten policy, rates must be pushed to a level where restrictiveness becomes truly meaningful. He said bluntly that the August inflation data “became the last straw that broke the camel’s back,” elevating the significance of the September meeting in the market’s eyes from a “single decision” to the starting point of a “policy path.”
Summary: Core inflation unexpectedly heated up in August, and combined with Warsh’s previous hawkish remarks, rising oil prices, and upward consumer inflation expectations, the probability of a Fed rate hike next week soared to more than 85%. The market’s focus has shifted from whether to raise rates to the path of rate hikes. If Warsh chooses to raise rates, it could trigger political pressure from the White House, and a communication approach lacking forward guidance will also increase market pricing risks.
