MFS: Fed likely to raise rates by 25 basis points
By Kish Pathak and Erik Weisman
The Fed is likely to hike rates by 25 basis points, moving its target range to 3.75%-4.00%.
In our opinion, Chair Warsh’s Jackson Hole speech had signalled policy tightening. Governors Waller and Williams leaned dovish, post Jackson Hole, but the August Consumer Price Index (CPI) print should tilt the balance in favor of a hike.
FOMC Vice Chair Williams advocated for a 'wait and see' approach while noting that inflation was moving down slowly as the effects of tariffs faded. But he did not specify how long he wanted to observe incoming information to make up his mind. Governor Waller had more directly hinged the September decision on the August CPI print.
One month’s data does not make a trend and therefore overemphasis on the August CPI data seems odd. Nonetheless, the latest core inflation number does not suggest that inflation is unambiguously on the path to 2.0%. Moreover, the economy and the labor market are proving resilient to the oil shock as financial conditions remain extremely easy.
Importantly, the energy price shock is proving more durable with no end to the Iran conflict in sight strengthening the case for tightening policy. The Fed has been worried that an extended period of high inflation, irrespective of cause, risks de-anchoring inflation expectations. Moreover, a long period of high energy prices increases the possibility of second-round effects.
The risk is that the Statement of Economic Projections median core PCE (Personal Consumption Expenditures Index) inflation forecast moves higher. The median long-term Fed Funds dot, currently at 3.1%, may also creep up given the recent resilience of the economy, but the market is already priced for a much higher neutral rate.
