The market and the consensus of experts practically consider a 25 basis point increase by the Federal Reserve of the United States in the meeting this Wednesday to be certain, given the persistently high inflation data in the largest economy in the world and with a Kevin Warsh determined to keep prices under control.
U.S. inflation returned to 3.4% in August, the same figure as in July, with no clear signs of moderation. Moreover, it remains above the 2% target set by the Fed for the past five years.
The conflict in Iran has increased energy costs and pushed the general price index upward, while the U.S. labor market continues to show remarkable strength. With this scenario and considering the Fed's dual mandate — price stability and maximum employment — investors interpret that the president of the central bank, Kevin Warsh, is compelled to raise the reference rate.
Warsh addressed the problem of inflation forcefully a few weeks ago at the Jackson Hole symposium, admitting that the situation is "concerning." Although he acknowledged that the summer inflation figures were better than expected, he stated that "they do not indicate to me that the underlying trends have improved significantly" and emphasized that the institution has "work to do" as long as inflation remains rampant.
This shift in tone, firmer and more aggressive regarding price control, is one of the reasons analysts take for granted a new tightening of monetary policy. From ING they recall that "after adopting a more restrictive stance in June and then retracting in the July FOMC press conference, President Warsh was pressured to clarify the Federal Reserve's reaction function under his leadership at Jackson Hole."
In its July meeting, the Federal Open Market Committee (FOMC) decided to keep interest rates within the target range of 3.50% to 3.75%. Now, the market's baseline scenario is that the range will be between 3.75% and 4% after this Wednesday's decision.
Jenny Zeng, Chief Financial Officer of Fixed Income at Allianz Global Investors, believes that this level of rates does not yet imply a clearly restrictive environment and emphasizes that "overall financial conditions remain loose." In her view, "furthermore, within the Committee, support for new rate hikes is growing, something that was evident in July when three members cast dissenting votes advocating for a more aggressive stance."
In the last meeting, the FOMC broke unanimity: 9 members leaned towards maintaining rates and 3 spoke in favor of a greater tightening. Days later, Governor Michael Barr already anticipated that he would support an increase in the benchmark rate if inflation continued to rise.
The behavior of the U.S. debt market, impacting numerous international markets, also weighs on the Fed's deliberations. The yield on the 10-year bond reached highs not seen since 2007 this Thursday, a movement that reinforces the bet on a more restrictive monetary policy. However, with the hike practically priced in, investors' attention will focus on the new official projections.
Afonso Borges, Fixed Income researcher at Julius Baer, recalls that "the first rate hike in 1,148 days is already widely priced in by the market, so the evolution of U.S. Treasury bond yields will now depend on inflation projections and official rate forecasts. Our revised forecasts for the 10-year bond are below the 'forward' rates, as we anticipate a monetary tightening less than what the money market rates are pricing in."
Inflation and rate forecasts — the well-known 'dot plot' — will concentrate much of the interest this Wednesday, along with Warsh's appearance after the decision. Markets are already pricing in the possibility of another additional hike in the coming months, although the outcome will depend on price developments and the geopolitical context.
Tiffany Wilding, economist at PIMCO, points out that "we now expect the Federal Reserve to raise rates by 25 basis points in September, with the possibility of some more hikes in the future. However, if inflation data continues to improve, it is possible that additional rate hikes may ultimately not materialize."
Clash with Trump over rates
A new increase in the price of money would place Kevin Warsh at the center of the controversy just five months after assuming the presidency of the Fed, as it clashes with President Trump's persistent demands to lower interest rates, a similar standoff to the one he had with his predecessor, Jerome Powell.
"Lower interest rates because the US has a much stronger credit than in recent times!" the president demanded ten days ago in a message on social media. In that same intervention, he warned that if his request is not met, he would stop trading with the countries with which the United States has a deficit.
Trump even went so far as to demand that the Fed set the interest rate at the lowest level in the world, "like in the old days," and maintained that the central bank, with its "new and great leader" —referring to Warsh—, has to "wake up."
The public pressures from the American president to force a cut in the reference rate have become a constant of his mandate. Although after Warsh's arrival at the presidency of the Fed the tone seemed to have relaxed, the latest statements from the occupant of the White House again raise the tension on the 'guardian of the dollar.'