Fed likely to skip rate hike next week, despite higher inflation reports.
Reports Show Inflation Tick Up, but Fed Expected to Hold Off on Rate Hike
Recent reports indicate that inflation has increased slightly, but economists and investors believe that the Federal Reserve will refrain from raising interest rates at its upcoming meeting. The Fed, which has been gradually increasing rates for over a year, faces a challenging situation. While it aims to curb inflation by keeping rates high, it also wants to avoid tightening too much and potentially causing a recession. Adding to the complexity, inflation has now risen for two consecutive months after a year of decline.
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The consumer price index data for August revealed a 3.7% annual inflation rate, aligning with expectations but not aligning with the Fed’s desired direction for inflation. Prior to the release of the report, it was widely anticipated that the central bank would not raise rates in September, so the report did not significantly alter expectations. Steve Wyett, chief investment strategist at BOK Financial, stated, “The good news in this morning’s report is there were no real surprises. As such, we do not expect any change to the consensus outlook for a pause at next week’s Fed meeting.”
However, the producer price index, which measures wholesale inflation, rose to 1.6% for the year ending in August, surpassing the 1.2% predicted by most economists. The lesser-known PPI tracks the wholesale prices of goods, which eventually impact consumers.
Despite the hotter-than-expected inflation reports, investors remain confident in the likelihood of a rate pause. The Fed tends to move slowly and provide clear signals, so two inflation reports shortly before the meeting are unlikely to significantly impact their decision-making. Noah Yosif, an economist with the National Association of Federally-Insured Credit Unions, stated, “The expectation of a pause in tightening when the committee meets next week remains in place.”
The CME Group’s FedWatch tool, which calculates probability using futures contract prices, indicates a 97% chance that the Fed will maintain its rate target at 5.25% to 5.50% after the upcoming meeting. There is only a 3% chance of a surprise rate hike.
Looking ahead to the November meeting, predictions become less certain as the Fed has more time to analyze various data, including labor and inflation reports from September. The August CPI and PPI reports will also be considered when assessing inflation trends leading up to November.
While this report nudges the Federal Open Market Committee (FOMC) towards a more hawkish stance, the National Association of Federally-Insured Credit Unions (NAFCU) believes that even if future inflation data continues to exceed expectations, it is more likely to prompt the FOMC to maintain rates at their current level for a longer period rather than increasing rates further.
Looking even further into the future, over 31% of investors anticipate a rate hike after the November 1 meeting, and nearly 40% believe that rates will be higher in 2024 compared to the present.
Fed Chairman Jerome Powell has been cautious in his discussions about the Fed’s monetary policy agenda, carefully considering how high to raise interest rates without causing market instability. During his annual address, Powell stated, “At upcoming meetings, we will assess our progress based on the totality of the data and the evolving outlook and risks. Based on this assessment, we will proceed carefully as we decide whether to tighten further or, instead, to hold the policy rate constant and await further data.”
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What criteria does the Fed consider when deciding whether to raise rates, and does the current level of inflation meet those criteria
At Pantheon Macroeconomics, stated, “The Fed will see these numbers in the context of the broader inflationary backdrop and the ongoing trade uncertainty, concluding that there is no need to hike rates at this stage.”
One factor that may contribute to the Fed’s decision to hold off on a rate hike is the ongoing trade tensions between the U.S. and China. The threat of escalating tariffs and the uncertainty surrounding future trade policies have created a level of economic uncertainty that the Fed is carefully monitoring. With the potential for a trade war to impact global growth and potentially push the U.S. into a recession, the Fed may opt for a cautious approach and choose to keep interest rates steady.
Additionally, the recent increase in inflation may be viewed as temporary by the Fed. The rise in gasoline prices due to hurricane-related disruptions in the Gulf Coast played a significant role in the uptick in inflation. With these disruptions expected to be temporary, the Fed may see this as a transitory increase and therefore not warranting a rate hike.
Furthermore, the Fed has previously expressed a desire to see inflation reach its 2% target consistently before raising rates further. While the recent increase in inflation is a positive sign, it is still below the desired target. If the Fed believes that inflation is not yet at a sustainable level, they may choose to delay any rate hikes until it is.
Overall, while reports of increasing inflation may raise some concerns, the prevailing sentiment among economists and investors is that the Fed will hold off on a rate hike at its upcoming meeting. The central bank faces a delicate balancing act of curbing inflation without stifling economic growth or exacerbating trade tensions. With the recent rise in inflation seen as temporary and below the desired target, and considering the ongoing trade uncertainty, it is expected that the Fed will proceed with caution and keep interest rates unchanged for now.
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