The Federal Reserve is on track to lift interest rates at today’s policy announcement scheduled for 2:00 pm Eastern, according to Econoday.com’s consensus forecast. The projected hike coincides with rising inflation expectations in recent weeks, based on the yield spread for nominal less inflation-indexed Treasuries.
Fed funds futures are in agreement with the crowd that the central bank will squeeze policy again today. Futures are currently pricing in a 95% probability for a 25-basis-point increase in the target rate to 2.0%-to-2.25%, based on CME data this morning. If the prediction is accurate, the hike will mark the third time this year that the Fed has lifted rates, pushing the target Fed funds rate to the highest level in over a decade.
The broad economic picture supports the case for a rate hike, advised a research note published last week by Goldman Sachs economists Jan Hatzius and David Mericle. “Inflation is at target, the unemployment rate is below target and falling, and yet the funds rate remains 100bp below the Fed’s estimate of its neutral level,” they wrote. “Most FOMC participants now agree that this makes little sense — the Fed has some catching up to do.”
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Some analysts say that today’s Fed announcement will mark the end of the so-called accommodative regime for monetary policy. “This could well be the meeting where they nix the accommodative characterization,” says Jonathan Wright, a former Fed economist who’s now an economics professor at Johns Hopkins University. “At some point the language is obsolete and doesn’t have any value. You could remove the language or tweak it, and in the press conference [scheduled for 2:30 Eastern], Chairman Powell could cite uncertainty” about some variable as a rationale.
Meantime, the Treasury market’s inflation expectations have been rebounding lately after a period of weakening in the summer. Notably, the implied inflation forecast based on the yield spread for the 5-year maturity less its inflation-indexed counterpart edged up to 2.05% yesterday (Sep. 25), based on daily data published at Treasury.gov – the highest inflation estimate for the 5-year maturities since mid-July.
By contrast, formal inflation metrics eased in August. The core rate of the consumer price index (CPI), which strips out food and energy, decelerated to a 2.2% annual pace (based on unadjusted data) last month. But that’s still above the Fed’s 2.0% inflation target and the Treasury projections noted above suggest that pricing pressure will stabilize if not heat up in the September CPI report that’s scheduled for release in two weeks.
Note, too, that wage growth is picking up, another clue for thinking that inflation will firm up in the months ahead. Average hourly earnings for private-sector wages jumped 2.9% in August vs. the year-earlier level – a nine-year high.
Meanwhile, recent GDP nowcasts by two Fed banks point to continued economic growth overall. The New York Fed’s Sep. 21 estimate sees third-quarter output increasing a moderate 2.3% (seasonally adjusted annual rate) while the Atlanta Fed’s GDPNow model calls for a much stronger 4.4% gain (as of Sep. 19). Using the average of the two translates to a roughly 3.4% gain in Q3 GDP. That’s below the 4.2% increase reported in Q2, but it’s still strong enough to argue that a solid economic expansion endures.
Consider the upbeat macro outlook and the firmer inflation data leaves room to argue that the Fed has sufficient economic cover for another round of policy tightening today.
“Rarely are so many economic gauges of the US economy so strong — including employment, income, retail sales, business spending, manufacturing and small business,” notes Jack Kleinhenz, chief economist for the National Retail Federation, in a research note, CNBC reports. “The near-term outlook appears to be steady as she goes.”