Odds Of Fed Rate Hike Surge After Prices Rise Faster Than Expected

Investors are now overwhelmingly expecting the Federal Reserve to raise interest rates next week after new data Friday showed gas prices drove inflation in August to its fastest monthly pace since May, and consumer prices beyond food and energy rose more than expected.

If Fed Chair Kevin Warsh and his fellow policymakers follow through, the rate hike would come less than two months before a midterm election that will determine control of Congress — the kind of political optics that the Fed tries to avoid. It would also anger President Donald Trump, who has made clear he chose Warsh in the hope that he would push borrowing costs down.

But markets expect the Fed chair to make good on the speech he gave in Jackson Hole, Wyoming, last month, where he contended that “the Fed’s predominant focus right now should be on prices.”

“If you don’t deliver after that big speech, people are really going to be like: ‘This is not a credible Fed,'” said Omair Sharif, president of Inflation Insights.

Indeed, the stakes for Warsh are higher than just the threat of Trump’s wrath. A rate hike so close to an election might further panic Republicans who are already grappling with how to message on the economy in the midst of an unpopular war that has driven oil prices above $100 a barrel in recent days. Still, a lack of action by the central bank could hurt consumers more.

A move by the Fed to raise rates could actually lower long-term rates because markets will have increased confidence that the central bank is willing to battle inflation, which would lower the risk that it will have to do more to kill it later. Rates on U.S. government debt with a maturity of 10 years are politically important because they affect people’s mortgage rates and other longer-term consumer loans.

That is, a failure by Warsh to convince markets of his credibility could raise borrowing costs anyway, if the Fed does nothing. After the Labor Department reported Friday that the consumer price index rose 3.4% over the 12 months ending in August and core inflation — minus food and energy — rose 2.4%, the market odds for a rate hike stood above 85%, according to CME’s FedWatch tool.

Guy LeBas, chief fixed income strategist at Janney Montgomery Scott, said markets are looking next week to see if “a Warsh Fed shows a willingness to fight inflation in its action rather than its words.”