Fed’s Hawkish Stance Like Dancing On A Tightrope

Fed Chair Jerome Powell has said that “pain” could be required to suppress high inflation, implying that the Fed is willing to accept a recession in order to cool inflation. This is why Wednesday’s interest rate hike is more like dancing on a tightrope with a potential risk of dragging the US economy in recession.

The question now is: How much pain is the Fed prepared to tolerate to keep inflation under control? Fed Chair Powell expected to talk tough again on inflation tomorrow and double down on doing whatever it takes to cool inflation when he gives his press conference at 2:30 PM tomorrow.

Expectations are mixed with regard to how much Fed will increase the US interest rate with some 80% economists bet on a 75bps hike while 20% expect 100bps. This difference of forecast has created some fluctuations in the dollar, as well as the stock market.

The Fed, like almost all major central banks, still insists that policy decisions are data-led, so, last week’s CPI reading acted as a bucket of cold water on the markets, because headline inflation was above expectations and core inflation continued to surge. Both readings consolidated Fed’s keeping its aggressive hiking stance.

FOMC meeting has not convened since July, so expectations for what the Fed will do this time have to take into consideration the last two inflation reports. July CPI figures were substantially better than the August’s.

There was such a strong reaction to the CPI data partially because it came as a surprise. July data was implying a possibility for the Fed to start moderating the pace of hikes. Prior to the release, the consensus was for 75bps, and dissenters were arguing for 50bps.

Several Fed officials have said that interest rates are getting near “neutral”, which is the point at which the Fed seemingly will start moderating its aggressive hiking. It’s estimated that it is around 3.5%. Another 75bps would not only push the rate above where it was in 2018, but up to 3.25%.

Up till now, rates were expected to remain high for at least the first quarter of next year. A change in those expectations could determine where the market goes after the FOMC meeting.

The Fed could also ramp up their quantitative tightening in September, by letting up to USD95 bn roll of the balance sheet every month.