The Federal Reserve is widely expected to raise its benchmark interest rate on Wednesday, marking the first increase in three years. This move is intended to combat persistently high inflation, and it positions the central bank at odds with President Donald Trump, who has advocated for a rate cut.
While not guaranteed, most analysts and economists anticipate a rate hike following comments from Federal Reserve Chair Kevin Warsh two weeks ago. In a speech at the Fed's annual conference in Jackson Hole, Wyoming, Warsh indicated that the central bank had not yet achieved its goal of controlling inflation. This stance deviates from the signaling practices of his predecessors.
A rate increase would introduce another significant shift in a volatile economic period. As recently as March, the Fed had projected a single rate cut for the year. However, escalating geopolitical tensions, particularly the flare-up in the Iran conflict, have led to sharp increases in oil and gas prices, suggesting inflation may remain above the Fed's 2% target for an extended duration.
Economist Kristin Forbes of MIT's Sloan School noted the sensitivity of consumers and companies to high inflation, leading to quicker price increases. She believes the risks lean toward more persistent inflation rather than a swift decline.
Accelerated investment in AI data centers has also contributed to inflation and higher longer-term interest rates, although some leading companies are now discussing a slowdown in the technology's development.
The potential rate hike occurs just seven weeks before the midterm elections, where high prices and affordability are significant concerns. Trump has publicly urged the Fed to lower rates, stating that the U.S. should have the lowest interest rates globally. Trump had previously been a vocal critic of Fed Chair Jerome Powell, breaking with the tradition of presidential deference to the central bank's independence.
Kevin Hassett, Trump's top economic adviser, stated on CNN that Trump respects the independence of Fed Chair Warsh. However, Hassett also suggested in a Fox News interview that raising rates so close to an election could be ill-advised, emphasizing the Fed's role in staying out of electoral processes.
Financial markets, however, appear to anticipate the Fed will proceed with a rate hike. Futures prices indicate a 90% probability of an increase, a sentiment that grew after a recent inflation report showed persistent price pressures and a rise in core inflation in August. Following this report and Warsh's strong remarks on inflation, many economists believe he must raise rates to maintain credibility with financial markets. A failure to act could lead to spikes in longer-term interest rates, similar to reactions seen after a late July Fed meeting.
Michael Feroli, an economist at JPMorgan Chase, wrote that the Fed Chair's repeated warnings about inflation risk undermining institutional credibility without concrete action. While some Fed committee members still anticipate inflation to subside naturally, Warsh has not echoed this view, stating that recent reports do not indicate improved underlying trends and that further action would be necessary if this improvement is not seen soon.
Ironically, a Fed rate hike could potentially lower longer-term interest rates for consumers on mortgages and auto loans by reinforcing the Fed's commitment to controlling inflation. Some of the recent increase in mortgage rates may stem from investor concerns about the Fed's resolve against inflation.
If a rate hike occurs, Warsh will face further questions regarding the number of future increases, their effectiveness in controlling inflation driven by factors like oil prices, and the Fed's response if an AI-driven economic slowdown necessitates rate cuts.
Matthew Luzzetti, chief U.S. economist at Deutsche Bank, suggested that a single rate hike is unlikely to significantly impact the economy and that multiple increases are probable. He indicated that Warsh's characterization of potential hikes could signal future policy, such as unwinding previous cuts, which might imply two additional increases. Alternatively, a hike framed as "risk management" to ensure inflation falls could suggest fewer increases. Wall Street traders, based on futures prices, anticipate three hikes in September, December, and March.