Why interest rate expectations are pointing north

At the Kansas City Federal Reserve’s annual symposium in Jackson Hole, Wyoming, last week, Fed Chair Kevin Warsh said underlying inflation trends have not “meaningfully improved.” That means, he said, that the Fed has “work to do.”

In response to that characterization, FedWatch predicted Monday that there’s a 66% chance the Federal Open Market Committee will hike by a quarter-point at its upcoming September meeting. By tracking “target rate probabilities” on short-term interest rates, FedWatch also predicted a roughly 50% chance of another rate hike at the December FOMC meeting.

Inflation hawks, like senior economist Dan North at credit insurer Allianz Trade, think the futures market has it exactly right about the Fed’s next interest-rate move.

“There’s been no progress on inflation. We’re right back to where we were before the war started,” North said.

He pointed out the personal consumption expenditures price index is nowhere near the Fed’s 2% target.

“Without an interest rate hike, you’re going to have a hard time reaching that,” North said. “We’re still quite a ways from it, and it’s been very, very sticky. An interest rate hike is certainly warranted.”

In the dovish camp is Jay Hatfield, chief investment officer at Infrastructure Capital Advisors. He argued the government has been overestimating headline inflation, and the core measures will come down soon — even if oil prices stay elevated.

“We think it would be ill-advised to raise rates at this juncture. But we do acknowledge that the majority of the FOMC, which is what matters, absolutely does want to raise rates,” he said.

One reason Warsh and his fellow Fed governors may want to raise rates is to demonstrate their political independence from President Donald Trump, who wants lower rates to stimulate the economy.

Economist Erasmus Kersting at Villanova University sees Chair Warsh playing a careful game: “Not painting himself into a corner and having to raise rates. But at the same time, he is willing to take that step if necessary. The data’s not screaming for a move in one direction or another. This is not a crisis.”

But what if the Fed does hike rates soon. Would that be a crisis?

It surely wouldn’t help the cost of borrowing, said Guy Cecala at Inside Mortgage Finance. He pointed out that mortgage rates are already approaching 7%.

“Just a deal-killer. I don’t think there are any indications rates are going to come down. U.S. debt level and deficit, an ongoing war, gas prices — nothing bodes well for the mortgage market,” he said.

The consumer economy, which is already showing signs of inflation-related fatigue, might slide more if the Fed raises rates, said Jeff Klingelhofer, managing director at Aristotle Pacific Capital.

“We are all having to adapt to a world of higher interest rates. Every consumer is feeling that pinch, is feeling that pressure,” he said.

As borrowing costs go up, inflation eats away virtually all of our wage gains at work.