The likelihood of the Federal Reserve raising interest rates next month has diminished following a set of soft inflation and employment data. But the minutes of policymakers' last meeting suggest a hike cannot be ruled out.
The center of gravity on the central bank's rate-setting Federal Open Market Committee (FOMC) has shifted in a more hawkish direction, as evidenced by the three votes to raise rates in July. That was the biggest single, one-way dissenting "bloc vote" on the fed funds rate since September 2016. There was an 8-4 split as recently as April, though one of those dissents was for a rate cut, and three were against the easing bias in the statement.
The language of the minutes released on Wednesday suggests more than three officials could be voting to raise rates at the September 15-16 meeting. "Several participants favored an increase of 25 basis points" at the July meeting, the minutes showed, while "many participants" said policy tightening will likely be needed to get it back down to the Fed's 2% target.
For those unfamiliar with the nuances of "Fedspeak" when the number of participants advocating a position is referenced in the minutes, "several" is less than "many", while "some" is more than "several" but also less than "many". Got that?
As a caveat, only 12 of the FOMC's 19 members vote at any given meeting, so some of those officials indicating a readiness to raise rates might not be current voters. Regardless, the three dissenters were clearly not outliers. Governor Christopher Waller said last month that higher rates could be required in the "near term," and Philadelphia Fed President Anna Paulson earlier this month indicated she was still "open" to raising rates. Waller and Paulson are both voting members this year.
It therefore doesn't take a huge leap of faith to imagine that the 9-3 vote in July could become a 7-5 split next month, depending, of course, on incoming personal consumption expenditures (PCE) price index and consumer price index (CPI) inflation data, as well as the August employment report.
"The headline (June inflation and labor market) data may look weaker but those disruptions are look-through events," Diane Swonk, chief economist at KPMG U.S., posted on X on Wednesday. "September is still a live meeting for a hike."
To be sure, historical precedent argues against a hike next month.
The Fed rarely hikes rates so soon after a weaker-than-expected nonfarm payrolls report. According to Warren Pies, founder of 3Fourteen Research, this has only occurred at two of the last 89 Fed meetings that have followed pre-revision monthly job losses – and you have to go back decades to November 1999 and November 2005.
Interest-rate futures markets also suggest a hike next month is unlikely, but with roughly one-in-three odds, the probability is not negligible.
The political calendar is also a consideration. Fed members probably won't want to leave themselves open to accusations of political interference by raising rates in October, just days before the November 3 midterm elections. That makes December more likely, but could also keep September in play.
The question is whether June's surprisingly soft inflation readings are a blip, or the beginning of a more sustained trend. As "many" Fed officials noted at the July meeting, the re-escalation of war in the Middle East has "significantly" clouded the inflation outlook. Prolonged conflict – which appears very likely at this point – will put supply chains under even greater stress.
Indeed, energy prices are already rising again. Crude oil LCOc1 is now 35% higher than it was a year ago, after retreating significantly following the U.S.-Iran memorandum of understanding on a ceasefire in June.
Perhaps even more importantly, the prices of refined oil products – which are what households and businesses actually consume – are facing severe upward pressure. They are likely to remain elevated even if Washington and Iran agree to a permanent ceasefire because of the reduction in global refining capacity. Most notably, the price of diesel, the fuel that powers America's factories, industry and agriculture, is now near the highest on record.
Fed-watchers will now turn their attention to next week's symposium in Jackson Hole and incoming inflation and employment data, starting with the July PCE inflation report. It won’t take much of a hawkish surprise to make the September meeting truly "live."
TLT•
