The Federal Open Market Committee kept its policy rate in a range between 3.75% and 4% on Wednesday as it opted for the status quo days before the midterm elections.
While Fed Chair Kevin Warsh dislikes forward guidance, the two dissents in the FOMC vote, from Fed Governor Lisa Cook and Cleveland Fed Beth Hammack, tell us that there is a growing faction on the FOMC—we think a majority—that is ready to hike rates in December and again in March to put inflation on the road back to price stability.
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Those dissents to a certain extent set the predicate for a form of forward guidance from the FOMC board and the regional presidents.
It would appear that the board and regional presidents are not willing to accept the withdrawal of forward guidance preferred by Warsh, and that investors are taking cues from the dissents regardless of the Fed .chair’s preference.
The statement was modestly hawkish with the two key points on growth and inflation implying that the committee is prepared to hike rates at its December meeting.
The key paragraphs on that point state:
“Economic activity is expanding at a strong pace. While uncertainty remains elevated owing, in part, to geopolitical developments, domestic spending has been resilient. Productivity growth is strong, and capital investment is robust. Job gains have kept pace with the workforce, and the unemployment rate has changed little.
“Inflation remains elevated. The accumulation of more information will help the Committee determine the policy stance appropriate to ensure a timely return of inflation to the Committee’s 2 percent goal. The Committee will deliver price stability.”
Despite inflation increasing rapidly in the September Consumer Price Index and Producer Price Index, the committee decided to hold which in our estimation creates conditions where the Fed will have to play a bit of catchup either in the guise of a 50 basis-point hike in December or a greater number of hikes than the two the market has already priced in.
Either way, pricing pressures are apparent, and we forecast a 0.5% monthly increase in the personal consumption expenditures index, the Fed’s preferred inflation gauge, which will translate into a 3.6% year-ago increase when it is published on Thursday.
Assumptions that the trade-induced inflation and a war-induced energy shock would be temporary have proved illusory, and the price of inaction by the central bank is rising.
The forward look
The Fed has fallen behind the curve on inflation.
The cost of inaction will require the central bank to consider further rate hikes, which is why investors have priced in 25 basis-point rate hikes in both December and March, which is aligned with our RSM forecast.
Our research suggests that the Fed is underestimating what it will take to restore price stability as the energy shock intensifies.
Given the relentless buildout of artificial intelligence infrastructure, which appears to be insensitive to rate hikes, the Fed has a far heavier lift ahead of it than is commonly acknowledged.
We expect that the Fed will hike at every other meeting until there are obvious signs that inflation is abating, financial conditions tightening or the economy is slowing back below its long-term 2% trend.
Warsh’s remarks
If the Fed is ready to hike in December, why not hike today?
Warsh’s answer to that question was in line with past statements—an exploration of the unenumerated penumbras of his own reaction function. Essentially, he wants to see more information before hiking rates.
While the Fed will keep its eight meetings a year, one meeting next year will focus on monetary policy strategy and two in 2028 will focus on strategy, which will provide a bit of a twist on public understanding of central bank policy.
At those meetings, there will be no policy decision nor any update to the forecast. Warsh said that there has been no decision on whether the Fed would put out a statement on monetary policy strategy.
The takeaway
The Fed remained on hold as inflation rises in part to avoid hiking in front of a contentious election next week.
We recently conducted a simulation on growth, employment and inflation should the 10-year yield move from 4.5% to 6%.
Our modeling showed that the economy would prove far more resilient to higher rates with growth and employment modestly weakening but inflation barely budging, which implies a greater risk of rising rates ahead.
Since we published that work, the energy shock intensified again as oil and distillate prices have surged. Growth in gross domestic product in the first half of the year has now been revised to above its long-term trend and we think GDP will show a 3.4% pace of growth when the data is released on Friday.
In our estimation, the Fed will need to hike at least two more times and possibly more over the next five months, resulting in a tightening of financial conditions, an abatement of inflation and a slowing economy.
While we recognize the risk of tightening too fast, the rate insensitivity of upper-income household spending and AI-led investment warrant the Fed looking past that risk to create the conditions to restore price stability.
