Another hawkish hike

The Federal Open Market Committee (FOMC) – the policy setting arm of the Federal Reserve – is poised to raise short-term interest rates another quarter point to a range of 5.25% to 5.5% in July. The statement following the meeting is expected to leave the door open to additional rate hikes if needed. The Fed will be reluctant to raise rates and signal it is finished. 

The FOMC is focused on hedging against two mistakes:

1. It does not want to be head-faked by the recent deceleration in inflation and declare victory too soon; the Fed was already late on rate hikes and has seen the improvement in inflation stall out before. Supply chains remain fragile despite recent easing and are still susceptible to more disruptions than in the past.  
   
   
2. Financial markets have consistently front run the Fed on rate cuts; that has already eased credit conditions and could stoke an acceleration in growth; the concern is to avoid reigniting the embers of inflation before they have fully cooled.  
   

Separately, the Fed is likely to feel emboldened to go all the way to get inflation back to its 2% target. There was some debate on whether officials would have the stomach for the pain associated with getting inflation that low. Now that a soft landing looks more achievable, they are likely to worry less about the tradeoffs with unemployment and traversing what is usually the longest mile in the inflation battle. 

So far, Chairman Jay Powell has effectively corralled the cats and stopped dissents. Austan Goolsbee of the Chicago Fed has been clear that he believes the Fed should be done and could dissent but has been reluctant to actually pull that trigger. He is not alone. Raphael Bostic of the Atlanta Fed has voiced his desire to pause for longer; it would be a victory for Powell to get another unanimous vote. 

Debate within the Fed is expected to pivot on how long to keep rates elevated and how rapidly to cut rates once it can. The push to really get inflation down to 2% is expected to follow a bumpy path. 

Medical inflation, which was a primary driver of inflation in the 1980s and 1990s, is poised to pick up again after falling in the Fall of 2022 and early 2023. There is a quirk in the way that medical insurance is measured in the CPI versus the PCE measures of inflation; the CPI shows that medical insurance plummeted 24.9% from a year ago in June. Medical insurance will add to inflation again in October. Those shifts coupled with ongoing supply chain fragilities could create too high of a floor under overall inflation as we move into 2024. 

The FOMC is hoping that real or inflation-adjusted interest rates continue to rise as inflation cools. Any plateau in inflation would increase the pressure to raise rates again. The probability of another rate hike has fallen considerably but has not been eliminated with recent improvements in inflation.