Two Federal Reserve officials publicly argued on Thursday for raising interest rates in small, steady increments to combat inflation that remains above target.
Their remarks marked the central bank's first public comments since Democrats won control of Congress and expanded seats at the state level in the midterm elections, a shift that could alter the path of price pressures in the economy.
The officials spoke as stocks fell sharply on investor concerns about the technology sector's outlook, as the election results could slow investment growth in areas such as artificial intelligence, a topic that had sparked strong voter discontent.
Gradual Approach Emerges as Shared Theme
Cleveland Fed President Beth Hammack said in a speech ahead of an event in Zurich that she expects monetary policy will need to move to a restrictive stance to bring inflation back to 2% in a timely manner.
One of the central bank's most steadfast advocates for rate hikes, she argued the stance should be achieved through more frequent, smaller adjustments where possible, an approach that causes less disruption to households, businesses, and financial markets.
She also said gradual increases would help prevent an inflation mindset from taking hold among the public.
Richmond Fed President Thomas Barkin echoed Hammack's view on the path during remarks in Charlotte.
He said inflation is too high and is sitting at elevated levels rather than coming down.
For central bankers, the policy implication is fairly straightforward, and as for the pace of future hikes, gradual is reasonable.
September Hike Done, December Still Uncertain
Last week, the Fed held its benchmark rate steady in the 3.75%-4.00% range, even though policymakers have acknowledged inflation is above desired levels.
The Fed raised rates in September, and markets now broadly expect another increase in December, though the path beyond that remains unclear.
Both Hammack and Fed Governor Lisa Cook voted in favor of a hike last week.
The regional Fed president also dissented in late July when the Fed stood pat, and she has long argued that monetary policy and overall financial conditions are not tight enough to restrain the economy as needed to suppress inflation.
Notably, the two officials' comments on gradual tightening on Thursday came as Fed Chair Kevin Warsh deliberately avoids providing guidance on the policy path, preferring that markets assess the outlook on their own rather than rely on the Fed for a roadmap.
Still, even as Warsh steps back from the debate, many other Fed officials remain active in making the case for rate hikes and how they might take shape.
Election Results Could Ease Inflation Via Supply Side
Inflation had been gradually moving toward target before Trump returned to the White House, then heated up again due to trade tariffs. This year, the president's Middle East war and overheating investment in the tech sector, with companies racing to expand AI capacity, further intensified price pressures.
As Democrats took Congress, resistance to data centers also emerged at the local level.
That could bring some relief to the inflation outlook: limiting the scale of tech companies' construction would reduce demand for equipment and other related inputs, thereby easing price pressures.
Analysts at Evercore ISI said in a note to clients on Wednesday that permitting difficulties in large states, including Texas, will slow AI capital spending to some extent, ease overheating risks over the next year or two, and could stretch out the AI investment cycle.
The firm believes this will help keep the overall economy's supply and demand in balance without requiring more rate hikes, though it noted in a separate report that tighter financial conditions related to AI narrowly tip the scales toward one more increase.
TD Securities said it remains confident the Fed will raise rates by a cumulative 50 basis points by early next year.
The firm added that if the midterm elections ultimately lead to an end to the Iran war and/or a reduction in AI investment, the Fed may not need to tighten further after March.
Tech Selloff Drives December Hike Odds Down to 70%
Tech stocks continued to sell off on Thursday, with the Nasdaq index retreating 10% from its record closing high nearly a month earlier and posting its largest single-day drop in 19 months, as investors worried about AI companies' prospects amid a shift in the political winds.
The S&P 500 also fell as much as 4% in the afternoon, while the 10-year Treasury yield rose in the morning and turned lower in the afternoon.
Investors are also scaling back bets on tighter monetary policy and higher rates, even though a near-term hike remains the most likely outcome.
Futures market traders still bet the December 8-9 policy meeting will deliver a rate increase, but the probability has fallen to about 70% from more than 80% on Wednesday.
The Fed's policy outlook faces a fresh test on Friday with government jobs data.
Economists surveyed expect 65,000 new jobs in October, up from a weak 29,000 in September, with the unemployment rate expected to hold steady at 4.2%.
Fed officials have repeatedly said the relative stability of the labor market gives them room to bring inflation back to target, and that the employment sector itself is not a driver of price pressures.
Analysts at BMO Capital Markets believe the jobs data is unlikely to displace stock market volatility and the changing political landscape as the primary driver of the macro narrative.
The bar is very high for October employment data to shake the Fed's rate-hike ambition; as long as the unemployment rate stays near current levels, even a disappointing nonfarm payrolls report on Friday would not be enough to overturn the overall judgment that the labor market remains stable.
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