MNI FED WATCH: July Hike Looms, Future Increases Less Certain

The Federal Reserve is set to resume raising interest rates Wednesday after staying on hold last month, but with inflation showing clear signs of slowing, the debate is shifting to whether further increases are needed to ensure price rises are on a steady trajectory back to 2%.

Another quarter-point hike would take the fed funds rate to a target range of 5.25%-5.5%, the highest since 2001 and just a step below where the median official saw rates peaking in projections released last month.

The policy path is more uncertain from here, however, with most Wall Street analysts expecting further evidence of deceleration in growth and inflation and cooling in labor markets to preclude the need for any further tightening.

For now, Fed Chair Jerome Powell is expected to maintain a hawkish bias in light of upside risks to inflation. CPI fell by more than expected to 3.0% in June in a solid signal that disinflation is taking effect after 500 bps of rate hikes, but the surprising resiliency of the U.S. economy and a very strong labor market also lend weight to the BIS's warning last month that the last mile on inflation may be the most challenging.

REAL RATES TOO LOW

Some current and former senior Fed officials worry real rates are still too low to bring back price stability. "We still may not quite be in meaningfully restrictive territory," Richmond Fed research director Kartik Athreya told MNI. Former Dallas Fed senior adviser Joseph Tracy estimated real rates to be just above 50 bps and said they need to be well above 1% to slow the economy.

Even with headline price gains fading, the Fed will likely follow through on its June projections to clamp down on persistent underlying price pressures, former New York Fed economist Gianluca Benigno told MNI. Core CPI for June slowed to its softest monthly reading February 2021 but the year-on-year rate is still a hefty 4.8%.

Officials are also increasingly worried lags from monetary tightening have shortened compared to past interest rate hiking campaigns, raising the odds that hikes so far are not enough to tame inflation.

Consumer spending has stayed healthy while the unemployment rate has barely budged from historic lows, and initial jobless claims fell to a two-month low last week.

PASSIVE TIGHTENING

More dovish FOMC members argue the economy has yet to feel the full brunt of the Fed's past rate rises, and it would be prudent to hold rates while allowing falling inflation to gradually tighten policy.

Atlanta Fed President Raphael Bostic said in an interview he sees little urgency to move rates, and is instead prepared to keep rates high where they are through the end of 2024.

Passive tightening would do the job if inflation slows more or less as expected, but a mystery for U.S. economy now is where a projected decline in price pressures will come from, if not from a higher unemployment rate, former Dallas Fed policy adviser Evan Koenig told MNI. He and others are skeptical that Powell will achieve the soft landing he's aiming for.

Meanwhile, earlier market fears that illiquidity would force a premature end to QT have receded following an uneventful rebuild of the Treasury's cash account at the Fed after the debt ceiling resolution last month. That gives headroom for the central bank to keep shrinking its balance sheet for months to come.