Several major economic reports scheduled for release this week are expected to show the U.S. economy gaining further strength, providing additional support for the arguments of several Federal Reserve officials that interest rates should be raised further.
Recent data have shown that U.S. retail sales rose in August and business activity in September expanded at the fastest pace in more than five years, fueling market expectations that the Fed could raise rates again as soon as October.
But the good news on growth comes with a cost: inflation remains above the Fed's 2% target, forcing the central bank to consider another rate hike and putting further pressure on households and businesses.
Earlier this month, the Fed carried out its first rate increase in three years. Adding to the tension, the Fed's next interest rate decision will be announced just days before the closely watched midterm elections.
Data released this week could tip the balance in that debate to one side. Economists expect Wednesday's data to show that inflation-adjusted U.S. consumer spending rose sharply in August, likely posting the largest increase of the year.
At the same time, the year-on-year rise in the Fed's preferred core inflation measure is expected to be revised down by as much as 0.3 percentage points after adjustments, though the month-on-month figure is less reassuring. The core personal consumption expenditures (PCE) price index, which excludes food and energy, is expected to rise 0.3% from the previous month, faster than in the prior two months.
Then on Friday, the latest employment data will be released and are expected to show that job growth remains strong. As of last Friday, economists expected U.S. employers to have added about 90,000 jobs in September, with the unemployment rate expected to hold at 4.1%.
Michael Feroli, chief U.S. economist at JPMorgan Chase, said that if companies continue to hire at a recent pace, the gradual rate increase path currently priced in by the market could change. Feroli said, "Over the past few years, inflation appears to have been driven mainly by supply shocks. But if the labor market tightens further and wage growth accelerates, then I think we may begin to feel that there is a bit too much good news on the growth side."
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Fed Governor Michael Barr said further rate hikes may be needed to curb price increases, while Chicago Fed President Austan Goolsbee warned that the process of bringing inflation back to the Fed's 2% target will not be painless.
Goolsbee, Richmond Fed President Tom Barkin, Cleveland Fed President Beth Hammack and Philadelphia Fed President Anna Paulson also pointed to signs that the overall U.S. economy is building momentum, albeit at a slower pace. Hammack said on Friday, "What is worrying is whether we will see the economy begin to heat up. Right now, when I visit my district and talk with businesses, what I hear is that spending is very resilient."
A historic boom in artificial intelligence is driving construction and manufacturing activity, while businesses and households continue to spend in the face of an oil price surge linked to the Iran war.
As investors bet that the Fed will raise rates at least once more this year, bond yields have also become another factor policymakers must consider. Beth Ann Bovino, chief U.S. economist at U.S. Bancorp, said, "Part of the inflation we are seeing now is precisely because the economy is so strong. The possibility of another rate hike is becoming very real."
As of the end of last week, federal funds futures pricing showed that the market saw about a 65% probability of a Fed rate hike in October.
Fragile households need clarity. Not all parts of the U.S. economy are booming, and heavy reliance on the AI boom could ultimately become a hidden risk.
Patrick Harker, former president of the Philadelphia Fed and now a professor at the University of Pennsylvania's Wharton School, warned that higher borrowing costs will expose underlying vulnerabilities in the economy, especially for households in weaker financial condition.
Harker said, "I do think we have to be careful." He said the U.S. economy is currently "mainly driven by one very strong engine, namely data center construction and the accompanying power grid construction. The rest of the economy seems to be just gliding along, without much real growth."
New York Fed data show that credit card and auto loan delinquency rates have been trending upward in recent years. In the first quarter of this year, the credit card delinquency rate rose to its highest level since 2011 and remained elevated in the second quarter. With mortgage rates rising to their highest level in more than two years, the housing market has already stalled. For the real economy, the impact of higher borrowing costs cannot be ignored.
Rate shock: Aurelius Chaves is one of those feeling that pressure. He is president and owner of Midland Machinery, a company based in Tonawanda, New York, that makes road construction equipment. From employee health care to corporate insurance, he has had to deal with sharp increases in various costs. When the Fed raises rates, it not only increases the cost of his own loans but also raises financing costs for equipment dealers that buy his products.
Chaves said, "My products are sold through a dealer network, so when their costs rise, they start cutting inventory. I know very well how much more interest each 25 basis point rate increase will cost me next year."
Chaves said overall business remains stable at present, and several other indicators support that view. The Orange Book, compiled by Bloomberg Economics and Bloomberg Intelligence, found that more than two-thirds of industries mentioned accelerating economic recovery on recent earnings calls, with most attributing it to the AI investment boom.
That momentum has also drawn the attention of Fed Chair Kevin Warsh. In explaining the Fed's recent rate hike decision, he linked it in part to an optimistic outlook for accelerating economic growth.
Warsh told reporters on September 16, "Given all the shocks and uncertainties in the geopolitical environment, you begin to appreciate the resilience of the U.S. economy."
If policymakers decide to raise rates again on October 28, less than a week before the crucial midterm elections, Warsh's challenge will be how to communicate that message to Trump, who elevated him to the role.
Although U.S. President Trump has softened his harsh criticism of the Fed, he made his position clear at Warsh's swearing-in ceremony in May. Trump said at the time, "Unlike some of his predecessors, Kevin understands that economic prosperity is a good thing. We do not need to overreact, just let the economy keep prospering."
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