Fed on track for another 0.75 basis point rate hike after Powell's inflation pledge

The Federal Reserve appears on track to raise interest rates by another 0.75 percentage points this month as a result of Chairman Jerome Powell’s public pledge to reduce inflation even if it increases unemployment.

Investors in interest rate futures markets on Wednesday saw a roughly 75 percent chance the Fed would raise rates by another 0.75 basis points this month, according to CME Group.

Major U.S. stock indexes closed higher on Wednesday, with the Nasdaq Composite ending a seven-session losing streak. Oil prices fell to their lowest level since before the invasion of Ukraine. Treasury yields also edged lower, with the benchmark 10-year U.S. Treasury yield closing at 3.264 percent from 3.339 percent on Tuesday.

In a speech on August 26 in Jackson Hole, Wyo., Mr. Powell emphasized that the central bank commitment to raise interest rates enough to reduce inflation 40 year highs. “We will continue until we are sure the job is done,” he said.

His remarks and tone placed him among Fed officials who prefer a more aggressive pace of rate hikes compared to others, said Tim Duy, chief U.S. economist at research firm SGH Macro Advisors. A 0.75 percentage point rate hike would fit that approach, he said.

Mr. Powell’s speech showed that he was “very reluctant to give the impression that the Federal Reserve is not going to fight against inflationsaid Mr. Duy.

Fed Vice Chairman Leyl Brainard, a senior policy adviser to Mr. Powell, on Wednesday did not give a preference on the size of the next hike, but stressed the need to raise rates and stay at levels that would slow economic activity. “We’re in it for as long as it takes to reduce inflation,” she told a banking conference in New York.

Ms. Brainard explained why officials can expect rate hikes to moderate inflation in the coming months. She also highlighted how policymakers will ultimately have to balance the risks of raising rates too much with the risks of cutting rates too soon after economic growth slows. “At some point in the tightening cycle, the risks will become more lopsided,” she said.

Michael Barr, who was sworn in as the Fed’s vice chairman for banking supervision in July, said on Wednesday that he viewed the risks of allowing inflation to take hold as a bigger concern than the risk of raising rates too much. Higher interest rates could bring “some pain to the economy,” but “it’s much worse … to let inflation continue to be too high,” he told the Brookings Institution.

Fed officials have raised interest rates this year at the fastest clip since the early 1980s, raising their benchmark federal funds rate from near zero in March to range between 2.25% and 2.5% in July.

Federal Reserve Chairman Jerome Powell said the central bank should keep raising interest rates until it is confident inflation is under control. He spoke at the Kansas City Federal Reserve’s annual symposium in Wyoming. Photo: Jim Urquhart/Reuters

They face two main questions heading into their Sept. 20-21 meeting that will likely determine whether they approve another 0.75 basis point rate hike: how much higher they expect to raise rates in the coming months and what steps undertake to get there?

Several officials have signaled a willingness to raise the federal funds rate closer to 4% by the end of the yearor about 1.5 percentage points higher than the current level. This could be achieved by interest rate hikes of varying sizes at each of the Fed’s three remaining meetings this year.

An aggressive approach would point to a rate hike of 0.75 basis points at the upcoming meeting, followed by smaller increases at the next two, analysts said.

“The argument is that you would have to go much further than current interest rates and the risk of overshooting is still quite low,” Mr Duy said. “And you’d rather try to get ahead a little more than risk falling even further behind.”

St. Louis Fed President James Bullard said in an Aug. 18 interview that he was inclined in favor of a rate increase of 0.75 points this month to raise the federal funds rate to around 4% by the end of the year. “I really don’t see why you want to delay raising interest rates next year,” he said. “I think you can do it fairly quickly.”

Another option would be to raise rates by half a percentage point at each of the remaining meetings this year.

Officials will present new economic forecasts at their meeting this month, showing how high they expect to raise the federal funds rate by the end of the year.

Their next steps should be guided by “where we want to see interest rates through the end of the year and into next year,” New York Federal Reserve President John Williams said in interview last week. “If, based on the data, it’s clear that we should get significantly higher rates by the end of the year, then obviously that informs the decision at any given meeting.”

Cleveland Federal Reserve President Loretta Mester said Wednesday she believes interest rates are still providing stimulus to the economy as inflation-adjusted, or real, short-term interest rates are below zero. Ms. Mester said she expected the federal funds rate to rise to just above 4 percent by early next year and remain at that level.

“We need to get into positive territory for the real interest rate, and that means we’re going to have to do more work than where we are now,” she said in a webinar hosted by Market News International, a financial news service.

The U.S. labor market remains strong this year, with employers adding 315,000 jobs in August, stable profit. While inflation slowed down a bit in July, underlying price pressures and wage growth suggest it could run well above the Fed’s 2% target for some time. The Labor Department releases its August inflation report next week.

Ms. Brainard said on Wednesday that while July’s easing of inflation was a welcome development, it would take “several months of low monthly inflation readings to be sure” that inflation is returning to the Fed’s 2 percent target.

Mr. Powell is scheduled to speak Thursday in a moderated discussion at the Cato Institute, his last scheduled public appearance before the Fed’s upcoming meeting.

The Fed raises interest rates to fight inflation by slowing down the economy through stricter financial conditions – such as higher mortgage rates and bond yields, as well as lower stock prices—which typically curb spending, hiring, and investment. Any prolonged easing of financial conditions — such as falling yields and rising stocks — could backfire, fueling inflation.

Officials were uncomfortable with the way markets rallied – easing financial conditions – after their July 26-27 meeting, when Mr. Powell signaled at a news conference that the central bank would at some point slow its rate hikes.

The rally risks undoing some of the Fed’s work to slow the economy. The average 30-year fixed mortgage fell to 5.45 percent in mid-August, down from 5.82 percent in July, according to the Mortgage Bankers Association.

After the rally, “they are much more aware of the communication challenges facing the markets,” said Jonathan Pingle, chief U.S. economist at UBS. Mortgage rates rose to 5.94% last week, the MBA said on Wednesday.

Officials are trying to convey their expectation that rates will have to stay higher for longer, and “one way to send that message is with a third increase of 0.75 basis points,” Mr Duy said.

Write to Nick Timiraos c [email protected]

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