Prelude to a Rate Hike

When the Federal Open Market Committee (FOMC) meets on Wednesday and Thursday this week, it will affirm to markets and the public the commitment to raise rates in December. Look for the statement following the meeting to highlight the recent and welcome pickup in wages and a further drop in the unemployment rate.

The Federal Reserve has already dropped “accommodative” in reference to policy, despite what will remain accommodative policy. That said, the FOMC looks poised to raise rates even more in the year to come. There is a growing consensus within the highest ranks of the Fed that the “neutral” fed funds rate has moved up, after falling for much of the expansion.

There is a greater willingness to raise rates past the neutral point. The Fed has done a 180 degree turn in its view on inflation. What was once a concern that the economy was not warm enough has shifted to worries of overheating. Even former Fed Chair Janet Yellen has adjusted to the new environment, arguing that the risks of overheating and seeing a corrosive rise in inflation are now greater than the threat that disinflation once was. That means that the Fed is operating on a decision rule that would have been in place even if Yellen was still at the Fed, something that many miss in translation. Fed leaders who were once doves can become hawks if they are being consistent in their economics.

The most interesting part of this meeting will not be revealed until we see the minutes in three weeks. That is when the nuances of concerns regarding tariffs and supply chain disruptions will be revealed. The FOMC is proceeding with an assumption that a trade war with China will not escalate, which is prudent given the harsh political environment. Chairman Jay Powell has been reluctant to comment much on tariffs and deficits, saying that he is staying in his lane on policy issues.

Bottom Line
The Federal Reserve is focused on managing expectations for rate hikes in the financial markets and the public. Consumers already fully expect rates to go up. Financial markets are getting there.

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