The Federal Reserve remains on track for another round of tightening monetary policy at next week’s FOMC meeting, based on a several indicators. If the central bank announces another rate hike, it’ll mark the eighth increase since the Fed began squeezing policy post-recession in December 2015.
Market sentiment is clearly anticipating the Fed will roll out another rate hike at its policy announcement on September 26. Fed funds futures this morning are pricing in a 94% probability that the target rate will rise 25 basis points to a range of 2.0% to 2.25%, based on CME data.
The central bank has certainly laid the monetary groundwork for hikes by extending and deepening the contraction in inflation-adjusted base money (aka M0), also known as high-powered money that’s controlled by the Fed. The one-year trend in real M0 fell for a sixth straight month in August, sliding 10.7% vs. the year-earlier level – the biggest decline in nearly two years.
The policy sensitive 2-year Treasury yield is also pointing to an increasing likelihood that another rate hike is near. This widely followed maturity, which is considered an indicator of expectations for near-term monetary policy bias, held steady for a second trading day at 2.78% on Monday (September 17), a post-recession high, based on daily data via Treasury.gov.
Fed officials have been recently talking up the case for more policy tightening. Eric Rosengren, the president of the Federal Reserve Bank of Boston, for example, recently advised that higher rates are necessary to avoid threatening US financial stability with excessively low borrowing costs, which can trigger unwarranted risk-taking. Speaking to the Financial Times, he said “we do need to be concerned about financial excesses,” explaining that the historical record for unmanaged “boom-bust cycles” isn’t encouraging. As such, he recommended that the Fed “lean against the wind a little” via rate hikes.
By some accounts, the benchmark 10-year Treasury yield (2.99% on Monday) deserves to be modestly higher. “I think what we have to recognize is if we strictly looked at the fundamentals of the market, we should be between 3 and 3.25 percent, Jim Caron, fixed income portfolio manager at Morgan Stanley Investment Management, told CNBC on Friday.
Economic data of late offers support for more tightening. Headline retail spending advanced 6.6% over the 12 months through last month – close to an eight-year year. Consider, too, that the trend in private-sector employment continued to hold at a healthy 1.9% year-over-year increase in August. Meantime, several nowcasts for GDP growth in the third quarter see another strong gain in the cards – the Atlanta Fed’s GDPNow estimate as of September 14, for instance, projects a sizzling 4.4% gain.
One of the potential reasons to delay a rate hike is softer inflation data of late. Core consumer inflation eased to a 2.2% annual rate in August, the lowest since April. Implied inflation via Treasury spreads appeared to anticipate to weaker inflation. Note, however, that Treasury based inflation expectations have stabilized in recent days, implying that pricing pressure will now hold steady or accelerate going forward.
The fact that wage growth picked up last month, despite the slightly softer gain in consumer prices generally, is a distinction that the Fed is surely monitoring. Average hourly earnings increased 2.9% for the year through August, the biggest gain in nine years.
What might derail plans for the next rate hike? Surprisingly weak economic data are always on the short list of potential spoilers. But expectations for most numbers on tap for release between now and the Fed’s announcement next week (Wednesday, September 26) look encouraging. If there’s a case for standing pat, it’s not obvious in the data published to date.
“I still think that certainly three to four total increases for this year are reasonable and the data have been strong,” Federal Reserve Bank of Chicago President Charles said on Friday. “I will not be surprised if it’s four increases this year. I do still believe that a gradual increase in interest rates is appropriate.”