Fed Tilts Toward Third 75 Basis-Point Hike on Stubborn Inflation

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Federal Reserve officials are on track to raise interest rates by 75 basis points for the third consecutive meeting this week and signal they’re heading above 4% and will then go on hold.

A case can be made for going even bigger. But there are persuasive arguments for not delivering a shock 100 basis-point increase that will probably prevail when they gather Tuesday and Wednesday in Washington.

Since officials last met in July, the “totality” of data — to use Chair Jerome Powell’s phrase — shows the economy remains resilient and inflation is widespread and stubbornly high.

That’s hardened bets for another 75 basis-point increase instead of the smaller half-point move that was also on the table this week. But policy makers probably want to avoid hiking by an even larger amount because of the risk investors will see that triggering a US recession next year.

Such a reaction could have the unintended effect of increasing speculation for Fed rate cuts in 2023, lowering long-term bond yields, easing financial conditions and pushing monetary policy in the wrong direction.

“Going 100 basis points would energize the hard-landing people,” said Michael Feroli, chief US economist at JPMorgan Chase & Co. He acknowledges reasons why they might go for the bigger hike while forecasting a 75 basis-point move.

“Pushing back against expectations of easing next year is not merely a matter of aligning forecasts, but rather of exerting more influence over longer-term interest rates,” Feroli said.

Officials release their policy statement at 2 p.m. Wednesday and Powell will hold a press conference 30 minutes later. They’ll also update forecasts that are expected to show rates moving to 4% over the next few months — from a current target range of 2.25% to 2.5% — and holding a bit higher than that through 2023.

The long hold strategy is rooted in the idea that the committee needs to buy some insurance against inflation expectations going adrift, and avoiding the disastrous stop-go policy of the 1970s that allowed inflation to get out of hand.

Fed officials have emphasized they don’t see rate cuts next year — despite investors betting they will ease somewhat.

That signals they’re willing to overshoot on rates and impose higher economic costs, including more unemployment, because easing too soon could just stoke inflation all over again.

“I got burned last year,” Fed Governor Christopher Waller said Sept. 9 as he discussed when the Fed might retreat from restrictive policy. “And we are very cautious about getting burned again. It’s got to be a real, permanent, longer-term decline,” he said, referring to inflation.

Since then, core consumer prices rose by a more-than-expected 0.6% in August from the prior month. But a closely watched University of Michigan survey of inflation expectations over the next five to 10 years declined slightly to 2.8%.

Those arguing for a full percentage-point move this week say the Fed needs to get ahead of inflation while consumer spending remains robust amid a very tight labor market.

“The fall in oil and gasoline prices is going to boost spending, not contract it” as job growth continues, said Steven Blitz, chief US economist at T.S. Lombard.

He also favors the bigger move because it would also give Fed officials some flexibility to do less at their next meeting, on Nov. 1-2, a week before US midterm congressional elections in which inflation is a central topic.

If the Fed raised by 100 basis points, it would be the largest increase since the era of former Fed Chair Paul Volcker, who hammered inflation in the early 1980s with mega moves of as much as 400 basis points that pushed rates to a peak above 20%.

“You could probably make a case” for a 100 basis-point move, said former Fed Vice Chair Donald Kohn, who’s now a senior fellow at the Brookings Institution. “But I also wonder if that becomes a new baseline,” he added, noting that it could be unwieldy for the committee to downshift from there.

“They seem to be in a 75 baseline now, which is a pretty vigorous baseline,” Kohn said. “They have to be careful to not to react really strongly to each piece of information.”

Investors seemingly agree and are only pricing in a small probability for a bigger move, while economists surveyed by Bloomberg also expect them to go 75 basis points again.

“There is no reason to shock the market in a more hawkish manner with 100 basis points,” said Lara Rhame, chief US economist at FS Investments in Philadelphia, who notes that Fed officials didn’t opt for such a move at a time when rates were even lower.

A further consideration is the international context. The Fed is aiming for slower US growth, but not a synchronous global recession that could result in reverberating financial stress.

“With China and Europe slowing down together, it is unwise to go 100 basis points right now,” said Anna Wong, the chief economist at Bloomberg Economics. “A severe recession in Europe that widened credit spreads could knock a percentage point off US GDP.”