MNI FED WATCH: On Hold Again But Too Soon To Rule Out Dec Hike

The Federal Reserve is expected to keep interest rates on hold for a second straight meeting Wednesday but keep open the door to additional increases as officials debate whether a recent tightening of financial conditions will be enough to counter resilient economic growth and keep inflation on a downward path.

GDP grew 4.9% in the third quarter, the strongest pace since early 2021, and employers added 336,000 workers in September, far above trend estimates. The latest reading of trimmed mean PCE inflation was 4.0% annualized, well above each of the four months prior, and higher than its six-month growth rate of 3.2%.

Chair Jerome Powell on Oct. 19 touted ongoing progress toward the Fed's dual mandate of maximum employment and stable prices, but said further tightening could be warranted if "additional evidence of persistently above-trend growth" or "no longer easing" labor markets threaten further declines on inflation.

"The committee is proceeding carefully," he said. "We will make decisions about the extent of additional policy firming and how long policy will remain restrictive based on the totality of the incoming data, the evolving outlook, and the balance of risks."

HIGHER YIELDS

Financial conditions have tightened significantly in recent months, driven by longer term bond yields. That should should ease policymaker worries they haven't been forceful enough to bring inflation to heel, but the Fed will also need to follow through on its promise to hold rates near peak for some time, former Fed Vice Chair Alan Blinder told MNI.

While Blinder argues the Fed's "higher for longer" message underpins the move in yields, others say QT, uncertainty about a rising neutral rates, and a sharp increase in Treasury issuances have boosted term premia.

A Richmond Fed model of real r-star has risen nearly 2 percentage points since the pandemic and is running much higher than the Laubach-Williams model commonly cited in Fed deliberations.

Higher term premia would mean, all things equal, the economy feels the effect of higher interest rates for the same fed funds rate.

REAL ECONOMY

Still, the Fed would be more comfortable if the labor market were a little less tight, former Fed Board economist Bill English told MNI. The September dot plot showed officials thought a soft landing was possible even with another rate hike.

The hawks remain worried over the risk that inflation will persist at unacceptably high levels, with conventional Taylor rules suggesting real rates need to rise by up to 2 more percentage points.

Should stubborn inflation force the Fed to restart hikes after a months-long pause, a quarter point may not be enough, former New York Fed economist Matthew Raskin told MNI. Powell could be raising rates to 6% or more by early next year in that scenario, Raskin said.