September Fed rate hike – a done deal?

The case for moving

Warsh’s Friday speech set a clear bar for the Fed. He said the Fed ‘has work to do’ if the FOMC thinks that inflation will continue to move higher. This gives markets something to work with, although it isn’t an explicit commitment.

It is true that PCE inflation, the Fed’s preferred measure, remains above target. At present the core is sitting at 3.3%, well above the Fed’s 2% goal, though the Fed could argue that few central banks have got near the 2% goal for a long time, and indeed there seems to be only a flimsy basis for the target to even be at 2%.

Oil isn’t helping matter of course, and the fresh clashes between the US and Iran, though limited in scope, raise the prospect of further conflict and a continued closure of the Straits of Hormuz. Even more worryingly, food remains stubbornly at 3%, and with energy costs still feeding through it seems like higher prices are becoming embedded in the system. While core inflation excludes food and energy, a broader rise in prices seems likely in the coming months.

Meanwhile, credit and loan conditions in the US continue to point to ‘few signs of policy restraint’, according to the Fed chairman. This suggests that the current level of rates is not yet high enough to feed through to credit markets, a situation that could allow inflation to rise more aggressively.

The above are all reasons for why markets now price in around a 66% chance of a Fed rate hike, according to the CME’s Fedwatch tool.

The case for holding

However, there are still reasons to hold. Kevin Warsh explicitly said his remarks should not be viewed as a sign that action was imminent. He also didn’t provide a timetable, leaving markets with little to go on.

Inflation readings may yet soften too. Barclays expects inflation prints to be softer in coming months, and a weak inflation reading for August (due on 11 September) could take a hike off the table. In addition, Friday’s payroll report might also prompt renewed reservations about the wisdom of a move.

Much of the moves in markets appear to be related to the US-Iran conflict, which appears to be spiking into action periodically without turning into a sustained war as was the case in March.

It is important to remember that we have been here before recently. In June, markets became excited because the-then newly-minted chairman was sounding more hawkish than had been expected, given his closeness to president Donald Trump. Pricing for a rate hike by the end of 2026 shot up to 100% in mid-June and then again in late July, before reversing course in August. Now markets price in a 67% chance of a rate hike by the end of the year – will they have to reverse course again?

The Fed is also aware that rate hikes are not usually a ‘one and done’ situation. The inflation concerns will not go away after just one 25 basis point move. A sustained campaign would be needed, and there seems little likelihood of that happening into the mid-term elections and beyond. 

Rate hike is no guarantee

Warsh’s Friday speech gave the markets more to work with than they had expected (and more than I had expected too), and there are reasons for them to go. But it is still not a foregone conclusion, and the FOMC is more than capable of sounding hawkish without following through on their hikes.

The first trading day of September has seen a spike in volatility and losses for equities. We will have to wait and see as to whether the data might provide some colour before the Fed meets on 15 September and announces its decision a day later.