The Fed’s No-Win Decision Next Week

Why the Federal Reserve is Now Boxed into a Corner

The Federal Reserve will hold its interest rate steady at its September 15-16 meeting and for the rest of this year.

That was the conclusion of a Reuters poll released on Wednesday.

The story continued:

About 70% of economists, 65 of 93, in the September 4-9 Reuters poll expect ​the federal funds rate to remain in the 3.50%-3.75% range next week. That reading is down from 90% in August. The rest expect a quarter-percentage-point increase, which would be the ​first since July 2023.

Things changed quickly after a firmer-than-expected producer price index (PPI) report on Thursday and the consumer price index (CPI) report on Friday.

The August PPI report was driven by higher fuel and other commodity prices, which weighed on transportation and goods costs. Importantly, the survey of energy prices that fed into the latest PPI report ended on August 11 – before the recent increase in oil prices. This suggests that the influence of higher oil prices in August, and so far this month, was not reflected in this report.

On Friday, the headline CPI increased in line with market forecasts. But, core CPI, which excludes more volatile food and energy prices, rose 0.3%, hotter than the 0.2% that experts expected. In the eyes of many, that figure will have more influence on the Federal Reserve’s decision on whether to raise interest rates.

The CME Group’s FedWatch Tool on Friday morning reflected a 69% chance of a rate hike. After the CPI report, it jumped to nearly 90%.

So, is the Fed now fated to raise interest rates? Would a “hold” be a market surprise that would erode trust in the Fed even further? Could this be the start of a new rate-hiking cycle over the next several meetings?

And what will this mean for investor portfolios in the near term?

What Our Experts Think

After the Thursday PPI report, legendary investor Louis Navellier had already resigned to the idea of a rate hike. In a podcast to his Growth Investor subscribers, Louis noted that treasury yields spiked in the wake of the PPI report, but they also rose after the European Central Bank raised rates on Thursday.

It’s going to be hard for our Fed not to raise rates now because other central banks are raising rates, market rates are going higher. The bond vigilantes seem to be driving the bus. And the only thing that can probably stop the Fed from raising rates would be a phenomenal CPI report on Friday. It would have to be phenomenal, have to be well below expectations.

As we all saw, the CPI report was not “phenomenal.”

On Friday he shared another podcast with a little more detail.

So right now, it looks like the Fed has to increase rates because market rates went up. Now, Christopher Waller, one of the smartest people in the Fed, has been saying that inflation’s cooling, inflation’s cooling.

Even if Waller and Kevin Warsh didn’t want to raise rates, there will be other people on the FOMC who do. So, I’m going to be very curious what that vote is. And Warsh said he will not fight market rates. So, it looks like we’re going to have a Fed rate hike.

But that doesn’t mean we are starting a rate-hiking cycle, according to senior technology analyst Luke Lango, editor of Innovation Investor.

He characterized the CPI as “Goldilocks Hot.” It ran hot enough to ensure a rate hike next week, but not hot enough to confirm a new rate-hiking cycle.

Luke points out that underneath the hot headline…

There were enough disinflationary impulses to suggest that the hot August CPI report will be a one-off if (and this is the big part) the Iran War stabilizes over the next few weeks and months. For example, annualized core inflation on a three-month basis was just 2%, food inflation was basically flat, core goods inflation moderated to just +0.1%, computer prices fell, drug prices fell, and auto insurance costs fell.

Luke believes that if the situation in Iran stabilizes and oil prices retreat below $90 in the coming weeks/months, overall inflation could naturally cool from 3.4% today to 2% without much additional Fed tightening.

He also reminded his readers that Federal Reserve Chairman Kevin Warsh got the job with the all-but-written prerequisite that he cut rates.

Bottom line: It all hinges on the Iran situation.

Expert trader Jonathan Rose felt like the CPI headline number was already baked into the market, but the core number was running hotter than expected, which greenlights a hike. In his presentation on Masters in Trading Live, he noted that the increase was broad-based and not due to a single line item. Shelter, transport services, and used cars were all higher.

Jonathan told his viewers, “Don’t fear the Fed.” It does create a near-term headwind, but it historically recovers quickly, and the market is positive six months after a rate increase.

If you’d like to watch Jonathan’s take, click here and sign up for his free daily video!

Not a Unanimous Vote

Global macro investing expert Eric Fry, editor of Investment Report, sees it differently.

He thinks the odds of a rate hike are even. Here is Eric’s bottom line.

Despite the “near certainty” that the Fed will raise rates next week, I believe it’s a coin toss. Of course, all the traditional price pressures like rising oil prices suggest a rate hike would be a slam dunk. However, the non-traditional political pressure of a strong-willed president who doesn’t want higher interest rates might win the day.

No rate hike next week, especially not one week after Trump’s “Midterm Convention,” and just two months before the midterms.

So, where does that leave investors?

With a Federal Reserve that is truly boxed into a corner.

Raise rates, and policymakers risk tightening into an economy that may already be experiencing temporary, oil-driven inflation pressures. But if they hold rates here, they risk surprising a market that has rapidly come to expect a hike, raising new questions about whether political pressure is influencing monetary policy.

Either choice could create some short-term volatility.

But there’s an important distinction between a rate hike and a new rate-hiking cycle.

That’s the point I wouldn’t lose sight of next week.

Our experts may differ on some of the details, but none are arguing that investors should run for the exits. In fact, Luke believes inflation could cool considerably if oil prices retreat, while Jonathan reminds us that markets have historically recovered from the initial shock of higher rates.

As always, we will have to watch what comes after the announcement: oil prices, inflation data, Treasury yields, and, most importantly, whether the Fed signals that another hike is coming.

One rate hike may make headlines, but a new rate-hiking cycle could change the investment landscape.

We’ll keep you informed in the Digest.

Enjoy your weekend,

Luis Hernandez

Editor in Chief, InvestorPlace