Fed Hike Odds Surge to 73% as Inflation Hits Four-Year High

Key points

• The CME FedWatch tool indicates a 73% chance of a rate hike at the October FOMC meeting, up from previous expectations.
• Fed Governor Michael Barr stated that further policy adjustments are likely needed to ensure inflation returns to the 2% target in a timely fashion.
• S&P Global’s flash PMI data showed the services index at 58.7 (highest in 59 months) and the manufacturing index at 56.7 (highest in 53 months).
• Inflation measures in the S&P report hit their highest level since October 2022, driven by rising fuel, transportation, and wage costs.
• Job growth in the PMI surveys rose at a rate not seen since June 2022, with service sector employment expanding at its fastest pace since June 2002.
• The 2-year Treasury yield, which is sensitive to Fed policy expectations, rose more than 13 basis points to 4.9%.

Background

This development follows a unanimous 25-basis-point rate hike last week, which raised the benchmark rate to 3.75%-4%. Prior to this meeting, markets had priced in a 90%+ probability of this increase, driven by sticky inflation, a firming labor market, and crude oil prices above $100 per barrel. The Fed’s Summary of Economic Projections had centered on one additional hike this year, with rates ending next year at the current level. However, recent data and official comments have shifted market expectations toward a more aggressive tightening cycle, with some analysts forecasting two hikes this year. The 10-year Treasury yield had been near 5% ahead of the September meeting, reflecting energy-price fears and inflation concerns.

How outlets are covering it

CNBC emphasizes the market’s aggressive reaction to Barr’s comments and the S&P Global inflation data, highlighting the 73% probability of an October hike and the sharp rise in Treasury yields. The outlet frames the situation as a response to intensifying inflation pressures and a need for further policy adjustments. In contrast, Claudia Sahm of Stay-At-Home Macro focuses on the broader implications of Fed Chair Kevin Warsh’s press conference, questioning his approach to monetary policy and the mechanisms through which higher rates will lower inflation. Sahm notes that Warsh’s framing was more upbeat than typical for a rate-hiking cycle and that his views diverge from the rest of the committee, leading to market confusion and increased pricing of future hikes. While CNBC focuses on the immediate data and market reaction, Sahm provides a deeper analysis of the Fed’s internal dynamics and the potential costs of rate increases.

Why it matters

The surge in rate hike expectations reflects growing concerns about persistent inflation and its potential impact on the economy. Higher interest rates can slow economic growth and increase borrowing costs for consumers and businesses, potentially leading to a recession. The Fed’s decision to hike rates is a critical factor in determining the trajectory of the economy, and market reactions to these decisions can have significant implications for stock prices, bond yields, and overall financial stability. The current situation highlights the tension between the Fed’s dual mandate of price stability and maximum employment, and the challenges of achieving both in a rapidly changing economic environment.

What to watch

The next FOMC meeting is scheduled for October 27-28, where the Fed will decide whether to raise interest rates again. Markets are closely watching for signals from Fed officials, including Barr and Warsh, on the pace and magnitude of future rate hikes. The S&P Global PMI data and other inflation indicators will also be crucial in determining the Fed’s next move. Additionally, the impact of higher oil prices and transportation costs on inflation will be a key factor in the Fed’s decision-making process. Investors and policymakers will be monitoring the labor market and inflation data in the coming months to assess the effectiveness of the Fed’s monetary policy and its potential impact on the economy.