MNI FED WATCH: Debate Over December Rate Downshift In Focus

The Federal Reserve is expected to raise its benchmark interest rate by 75 basis points Wednesday to a target range of 3.75%-4%, and debate whether to scale back the size of its next hike in December as rates approach their projected peak.

Investors are currently pricing in a 50-50 chance of a smaller 50 bp increase in December, in anticipation that the FOMC may decide to slow down and monitor the effects of its actions so far. Some lawmakers have urged Chair Jerome Powell to pause rate hikes before job growth slows, while former Fed Governor Randal Quarles and others have warned rate hikes are more potent now due to extensive debt levels.

But upside surprises to inflation and employment between now and the Dec. 13-14 meeting could still necessitate a fifth straight 75 bp hike, former Fed officials told MNI. As such, Powell will be reluctant to lock in a rate stepdown at his press conference this week, the former officials said. (See: MNI: Data Hurdles Seen Between Fed And Rate Hike 'Stepdown')

December's move will come with a quarterly set of economic projections likely showing the FOMC intends to hold the fed funds rate at a higher level than the 4.6% they penciled in last month, probably 5% or higher.

ENTRENCHED INFLATION

Data since the FOMC last met in September show the labor market remains overheated and price pressures are widespread, but tighter financial conditions are gaining traction on demand, slowing the housing market and to a lesser degree household spending.

Inflation remains far above the 2% target, with the Fed’s preferred PCE inflation measure posting 6.2% in the year through September and core inflation coming in at 5.1%. Core services prices, heavily tied to the dynamics of supply and demand as well as wage pressures, jumped to fresh highs in the month. The employment cost index, a broad gauge of wage pressures, added 5.0% on a yearly basis in the third quarter, more than double its pre-pandemic trend, the Labor Department reported last week.

It could take months if not another year for tighter monetary policy and supply-side relief to alter the dynamics of high inflation, an Atlanta Fed economist told MNI.

OVERTIGHTENING

The Fed is mindful of the risk of a painful recession and global financial disruptions that could come along with aggressive tightening. Most economists expect a recession next year, but some hold out hope that potential labor market setbacks could be unusually mild.

And while speculation is rife that recent market turmoil could force the Fed to reconsider its resolve to keep raising interest rates, there is no sign the FOMC will waiver from its resolve to conquer inflation.