Fed odds flip toward 25bp hike

Kevin Warsh’s remarks at Jackson Hole last Friday did more than nudge market expectations. They reopened the possibility that the Federal Reserve could raise rates at its September 16 meeting after months in which investors had spent more time debating when cuts might begin. By Wednesday, traders were using fed funds futures to price a meaningful chance of a 25-basis-point increase, a reversal from the softer expectations that followed weak labor data earlier in August. The change has left the Fed facing a live policy decision with public disagreement among senior officials still visible. ### What exactly did Warsh say that moved markets? Kevin Warsh said on August 28 that the Fed would “have work to do” if policymakers were not confident underlying inflation was returning to the central bank’s 2% target. Reuters described the speech as the closest Warsh had come to acknowledging that rate hikes may be needed to ease price pressures. Jackson Hole mattered because it was Warsh’s first high-profile chance to lay out how he would run policy as chair. Reuters reported on September 2 that he had “opened the door to higher interest rates” and now faced pressure to decide whether incoming data justified following through in a way investors would see as consistent with his own words. (wifc.com) ### How far did market pricing move? CME Group’s FedWatch tool, which tracks probabilities implied by 30-day fed funds futures, showed traders leaning toward a quarter-point increase at the next meeting. CME says the tool reflects market expectations for upcoming FOMC decisions based on futures pricing. August 31 readings cited by other market reports put the chance of a 25-basis-point September hike near 66%, up from much lower levels before Warsh’s Jackson Hole appearance. (msn.com) CNBC reported on August 28 that hike odds had risen to nearly 56% immediately after the speech, while later market summaries citing CME data placed them closer to two-thirds. (cmegroup.com) ### Why are traders talking about a hike instead of a cut? July 30 inflation data kept the pressure on the Fed. Reuters reported that the Personal Consumption Expenditures Price Index was up 3.7% in the 12 months through June, still well above the Fed’s 2% goal, even as the monthly data showed some easing. Three Fed officials had already dissented at the July 29 policy meeting in favor of higher rates. (cnbc.com) Reuters reported on July 31 that Cleveland Fed President Beth Hammack, Dallas Fed President Lorie Logan and another dissenter argued tighter policy was needed because inflation remained too persistent. That backdrop helps explain why Warsh’s phrasing landed so hard. (wifc.com) Investors were not hearing a new inflation problem; they were hearing the chair signal that the Fed might act on one that some officials already believed required tighter policy. ### Is the Fed actually united behind that view? John Williams, president of the New York Fed, has sounded more confident that inflation is easing. (wifc.com) Bloomberg reported on September 2 that Williams said there was evidence price pressures continued to cool as the effect of tariffs faded and higher energy prices were not spreading broadly through services. (wifc.com) Williams had also told Reuters in an interview published August 3 that he expected inflation pressures to ease gradually, while adding that the Fed would respond with rate hikes if that did not happen. That left him less hawkish than Warsh in tone, but not fully opposed to further tightening. ### Why does the September meeting look unusually open? (bloomberg.com) September 16 is close enough that every speech, data release and market move now carries more weight. Reuters reported that Warsh’s credibility will be tested by whether the Fed’s action matches the tougher inflation line he laid out at Jackson Hole. (wifc.com) The next decision will be published with the Federal Open Market Committee statement on September 16, and traders will keep updating implied odds through CME’s FedWatch tool until the announcement. (cmegroup.com) (msn.com)