Inflation in the United States has now exceeded the Federal Reserve's 2% policy target for five consecutive years, continually testing the patience of policymakers. Although the Fed held interest rates steady at its July meeting, a growing number of officials believe the central bank should resume rate hikes as soon as possible to prevent high inflation from becoming entrenched. Another group of officials advocates for continued observation of the data, arguing that there is still hope for inflation to ease without further policy tightening. As the September meeting approaches, the internal divide within the Fed over whether to raise rates is becoming increasingly pronounced.
Persistent inflation expands the Fed's hawkish camp
In July, the Fed held the federal funds rate target range steady at 3.5%-3.75% for the fifth consecutive time. However, three voting members supported a 25-basis-point rate hike at that meeting, and several non-voting members have recently expressed similar views publicly, indicating that the camp favoring further tightening is expanding. Meanwhile, officials who continue to support holding rates steady argue that it is still possible to rely on time to allow inflation to naturally decline, though patience with persistent price shocks is also waning. James Egelhof, chief US economist at BNP Paribas, noted that the current economic data still holds significant uncertainty, making it insufficient to prove which scenario is unfolding. However, due to the lack of substantial improvement in inflation, the pressure on the Fed to act is rising.
Cooling labor market fails to settle policy debate
The July nonfarm payrolls data released last week showed an unexpected decline of 23,000 jobs, with employment figures for the previous two months also revised sharply lower, reigniting market concerns about a weakening labor market. However, this employment report has not provided clear direction for the Fed's policy debate. Richmond Fed President Thomas Barkin stated that the labor market remains in a "fragile balance" that has persisted for the past year and a half, and it has not become a major driver of inflation. Market focus has now shifted to upcoming inflation data in the coming weeks, including the Consumer Price Index (CPI) due next week, which will serve as the most important reference before the September meeting. According to the Fed's June economic projections, officials still expect inflation to return to the 2% target by 2028. However, as of June this year, the US CPI year-over-year increase was still at 3.5%, and the core PCE price index, excluding food and energy, was also up 3.3% year-over-year, raising market concerns about whether the Fed can successfully achieve this goal.
Where to start: "Wait and see" vs "Hike now"? Officials' views diverge
Officials supporting continued rate pauses argue that some inflationary pressures may be temporary, and rate hikes may not be the optimal choice. Claudia Sahm, a former Fed economist and chief economist at New Century Advisors, said that the biggest challenge facing the Fed is distinguishing between cyclical and structural factors affecting inflation and employment, with monetary policy being better suited to address the former. Fed Governor Lisa Cook stated this week that some factors favoring a decline in inflation are beginning to take effect, including the waning impact of tariffs, potential future declines in oil prices, and the easing of price pressures from AI investment. Premature rate hikes could cause unnecessary harm to the labor market. New York Fed President John Williams also said he still expects inflation to return to 2% by 2028, with his overall assessment unchanged. Following the weak jobs data, interest rate futures market expectations for a September rate hike have fallen from over 50% to around 40%.
However, officials supporting rate hikes argue that the Fed has little room left to wait. Neel Kashkari, President of the Minneapolis Fed, Lorie Logan, President of the Dallas Fed, and Beth Hammack, President of the Cleveland Fed, who all voted for a rate hike at the July meeting, have stated that further delays could necessitate larger rate hikes in the future. Additionally, Kansas City Fed President Jeff Schmid said this week that with consumer demand and business investment still strong, he does not believe current monetary policy is sufficiently restrictive and therefore supports further tightening to curb inflation.
Why just 10 ASX 200 shares? Powell stays silent; market focuses on Fed credibility
Compared to the increasingly open policy divergence among officials, Fed Chair Jerome Powell's stance appears more cautious. After the July meeting, Powell reiterated the Fed's commitment to price stability but declined to reveal the future rate path or specify under what economic conditions it would choose to raise rates. Due to the lack of forward guidance, long-term US Treasury bonds were sold off, driving long-term bond yields significantly higher, and market inflation expectations also rose. St. Louis Fed President Alberto Musalem stated that this market reaction underscores the need for the Fed to maintain its policy credibility through effective communication and necessary actions. Torsten Slok, chief economist at Apollo Global Management, noted that the issue is no longer just about economic data but about the Fed's policy credibility. "Inflation has been above target in the US since 2021, which is a very long time for the world's most important central bank." Mark Zandi, chief economist at Moody's Analytics, added that with the Fed's policy statements becoming more simplified and Powell rarely revealing his policy thinking, it has become more difficult for outsiders to gauge the internal stance of the FOMC. As the September meeting approaches and the end-of-month Jackson Hole Global Central Bank Symposium takes place, the market expects the debate within the Fed over whether to raise rates to continue heating up.
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