The Federal Reserve is widely expected to raise its benchmark interest rate on Wednesday for the first time in three years, a move aimed at combating stubbornly high inflation that could put the central bank at odds with President Donald Trump's calls for a rate cut.
The potential rate hike comes just seven weeks before the midterm elections, where high prices and affordability have become central issues. Trump has publicly urged the Fed to lower rates, stating on Sunday that "the United States is so strong we should be paying the lowest interest rate in the world." He has previously criticized Fed Chair Jerome Powell, breaking with the tradition of presidential deference to the central bank's independence.
Despite Trump's demands, most analysts and economists anticipate a rate increase following a speech by Fed Chair Kevin Warsh two weeks ago at the annual conference in Jackson Hole, Wyoming. In that speech, Warsh indicated that the Fed had not yet achieved its goal of controlling inflation.
Financial markets are pricing in a high probability of a rate hike. Traders currently see a 90% chance of an increase, according to futures prices, a figure that rose after a recent inflation report showed persistently high price levels. Core inflation, which excludes volatile food and energy prices, also picked up in August.
Economists argue that Warsh must take action to back up his stern warnings on inflation to maintain the Fed's credibility with financial markets. Failure to raise rates could lead to a spike in longer-term interest rates, similar to what occurred after a July Fed meeting when markets perceived the central bank as unwilling to lift rates if necessary.
A rate hike could ironically help lower longer-term interest rates for consumers on mortgages and auto loans, as some recent increases in mortgage rates are attributed to investor concerns about the Fed's commitment to fighting inflation. Investors typically demand higher yields to own bonds when inflation is elevated.
However, the decision to raise rates will likely prompt new questions for Warsh, including how many more hikes the Fed plans, their effectiveness in curbing inflation driven by factors like oil prices, and the Fed's strategy if an economic slowdown, potentially influenced by the AI sector, necessitates rate cuts.
Some economists, like Matthew Luzzetti of Deutsche Bank, suggest that a single rate hike may have little impact and that multiple increases are likely. The way Warsh characterizes potential rate increases on Wednesday could offer insight into the Fed's future actions, potentially signaling whether the Fed views this as unwinding previous cuts or as a preemptive measure for inflation control.
Contributing factors to the current inflationary environment include the ongoing conflict in Iran, which has caused sharp increases in oil and gas prices, and significant investment in AI data centers, which has accelerated inflation and pushed up longer-term interest rates. Some companies involved in AI are reportedly discussing slowing the technology's development.