Stubborn inflation raises prospect of Fed rate hike

The Federal Reserve appears increasingly likely to hike interest rates next week, as inflation remains stubbornly elevated amid the war with Iran.

New data out Friday showed annual inflation remained unchanged in August, still well above the central bank's target 2 percent rate. This is raising expectations of a rate hike, even as President Trump pushes for Fed Chair Kevin Warsh to cut rates.

"There's no guarantee that the Fed will hike next week, but it's hard to see how the central bank can justify leaving rates on hold," Chris Zaccarelli, chief investment officer for Northlight Asset Management, said in a statement after the consumer price index (CPI) data was released Friday.

Jai Kedia, a research fellow at the Center for Monetary and Financial Alternatives at the libertarian think tank Cato Institute, said he has been advocating for the Fed to raise rates all year but suggested the central bank has lagged behind the realities of the economy.

"This is a standard problem now with the Fed and the way it's been doing policy over the past five or six years is that they tend to respond to economic developments way too slowly, and by the time they do so, the economic scenario has changed," he said.

"I think that it's probably fine for them to raise interest rates by 25 basis points," he continued. "But the macroeconomic realities were much worse the whole year when they chose not to raise."

The central bank's rate-setting panel is poised to meet Tuesday and Wednesday, with investors pricing in a nearly 87 percent chance that it hikes rates by a quarter-point, according to the CME FedWatch tool.

The CPI, a popular measure of inflation, rose 0.4 percent last month and 3.4 percent over the past 12 months, according to the Bureau of Labor Statistics (BLS).

While this was largely in line with expectations, core CPI, which excludes more volatile food and energy prices, came in slightly hotter than expected, ticking up 0.3 percent in August.

"That was not what the Fed wanted to see," Ryan Nunn, director of research for the Budget Lab, told The Hill. "It would like to see continued decline in inflation, and markets are responding to this by increasing their expectation of a rate hike next week."

White House spokesperson Kush Desai argued the data "reinforces how President Trump's targeted policy interventions are paying off, with dramatic month-over-month price reductions for beef, prescription drugs, and car insurance."

"These policies are having a lasting effect for everyday Americans, and will continue delivering as energy supplies increase, markets stabilize, and overall inflation declines again," he continued.

Looking at overall inflation, one of the key drivers of the monthly uptick in prices was gas, the BLS noted Friday. Gas prices rose 3.9 percent in August alone, accounting for more than a third of the increase last month.

Energy prices have surged amid the war with Iran. As the conflict has flared up once again in recent weeks, oil prices have jumped, with both the global and U.S. benchmarks crossing $100 a barrel Friday afternoon.

The average price of diesel also hit a record Friday at $6.05 a gallon, up 63 percent from a year ago, according to AAA.

This surge in energy prices "will probably tip the scale to a hike at next week's meeting," Bill Adams, chief U.S. economist at Fifth Third Commercial Bank, said in a statement.

Meanwhile, signs of stability in the labor market are also raising pressure on the Fed to hike rates. The August jobs report came in stronger than expected last week, with U.S. employers adding 162,000 jobs.

The central bank is tasked with a balancing act often referred to as its dual mandate, in which it aims for maximum employment and stable prices. If the labor market is in relatively solid shape, this shifts the focus to inflation.

"On the employment side of the Fed's dual mandate, our country is doing well. Labor markets are quite stable," Warsh said last month at a gathering of central bankers in Jackson Hole, Wyo., adding, "But on the price-stability side of our mandate, the numbers are more concerning."

He pointed to the personal consumption expenditures (PCE) price index, the Fed's preferred measure of inflation. It showed annual inflation staying flat at 3.7 percent in July.

"None of these measures are perfect, but they all tell a similar story: Inflation is running above our 2 percent target," Warsh said. "So the Fed's predominant focus right now should be on prices."

Lindsey Piegza, chief economist for Stifel Financial, suggested some Fed officials may be open to a "more patient approach" on rates. She noted that year-over-year core CPI sat at 2.4 percent, its lowest level in several years.

Friday's data "reinforces the storyline of accelerating prices and underscores the need for firmer policy," Piegza told The Hill.

"However, given the cooling in the core to a multiyear low, there is still a sizable portion of the committee that would support a more patient approach to policy adjustments and be willing, as Waller said, to give disinflation a chance," she added, referring to Fed board of governors member Christopher Waller.

Waller said earlier this month that "if there is continued progress toward our 2 percent goal, then I am willing to support holding the policy rate at its current level."

Kedia, however, argued that he thinks the best time to raise the rates would've been around March or April.

As Warsh braces for next week's meeting, he is also grappling with increasingly forceful demands from Trump to cut rates. This has long been a fixation for the president, who repeatedly feuded with Warsh's predecessor, Jerome Powell, on the issue.

Trump has given Warsh some breathing room at his first meetings leading the central bank, but it's unclear how long this will last. After last week's jobs report, the president called on the Fed to slash rates, threatening to halt trade with numerous countries if it does not.

"The Fed Board, with its great new leader, must get smart – BE PATRIOTS for a change," he wrote in a post on Truth Social. "High interest rates put the U.S.A. at a very unfair disadvantage, and I won't allow that to happen!"

National Economic Council Director Kevin Hassett said in July that he saw "no excuse" for raising rates.

Vice President Vance also chimed in last week, suggesting the Fed should lower interest rates to help ease mortgage rates. The 30-year mortgage rate hit a 14-month high Thursday, climbing to 6.76 percent amid a rise in global bond yields.

Despite this, some analysts now see even more rate hikes on the horizon.

"We do not expect the Fed to be one-and-done," Seema Shah, chief global strategist at Principal Asset Management, said in a statement.

"This is no longer simply about fine-tuning the economy," she continued. "After half a decade of above-target inflation, policymakers are likely to conclude that more than one hike will be needed to re-establish price stability."

Shah suggested that October may be "politically challenging" for another hike given the nearness of the midterm elections, making the next meeting in December "the most likely opportunity for the Fed to deliver a follow-up hike."

Distributed by Newsbank, inc.