Multiple key economic reports due this week are expected to provide further evidence that the US economy is strengthening, supporting the arguments of several Federal Reserve officials that interest rates should be higher.
Following recent data showing a sharp increase in US August retail sales and September business activity at its fastest pace in more than five years, market expectations for another rate hike as early as October have heated up.
Good news on growth comes with a sting: inflation remains above the Fed's 2% target, forcing the central bank to once again pressure households and businesses with rate hikes after raising rates earlier this month for the first time in more than three years. Adding to the tension, the Fed's next rate decision will be announced just days before the highly anticipated midterm elections.
This week's data could tip the scales in that debate.
Economists expect data due Wednesday to show that inflation-adjusted consumer spending in August posted its largest increase of the year. Although an adjustment to the methodology of the Fed's preferred core inflation gauge is expected to lower the year-over-year reading by as much as 0.3 percentage points, the monthly picture is less reassuring.
The core personal consumption expenditures (PCE) price index, which excludes food and energy, is expected to rise 0.3% month-over-month, faster than the previous two months.
The latest nonfarm payrolls data will follow on Friday, expected to show that job growth remains solid. As of Friday, economists expect employers to have added about 90,000 jobs in September, with the unemployment rate holding at 4.1%.
Michael Feroli, chief US economist at JPMorgan, said that if businesses continue to hire at recent pace, the picture of slowly rising rates could change. "Over the past few years, inflation seemed to be driven by supply shocks," Feroli said. "But if the labor market tightens and wage growth accelerates, then I think we would start to feel that the good news on growth is a bit too much."
Several Fed officials used speeches and public appearances last week to warn in succession that inflation remains too high. Fed Governor Michael Barr said further rate hikes may be needed to cool prices; Chicago Fed President Austan Goolsbee warned that the path back to the central bank's 2% target will not be painless.
Goolsbee, Richmond Fed President Tom Barkin, Cleveland Fed's Beth Hammack, and Philadelphia Fed's Anna Paulson also noted that the broader economy is gaining momentum — even if only gradually.
"The concern is, are we going to see things heat up?" Hammack said last Friday. "Right now when I travel around the district and talk to businesses, what I hear is that spending is very resilient."
A historic artificial intelligence boom is powering construction and manufacturing, while businesses and households continue to spend in the face of an oil price surge related to the war with Iran. Bond yields are another factor policymakers need to consider, and investors are betting the central bank will raise rates at least once more this year.
As of press time, federal funds futures pricing showed about a 70% probability of a rate hike in October.
"Some of the inflation we are seeing now is precisely because the economy is so strong," said Beth Ann Bovino, chief economist at Bank of America. "The possibility of another rate hike is becoming very real."
Fragile US Households and Businesses
To be clear, not the entire economy is booming, and heavy reliance on the AI boom could itself become a burden. Former Philadelphia Fed President Patrick Harker, now at the University of Pennsylvania's Wharton School, cautioned that higher borrowing costs will expose an underlying vulnerability, especially among fragile households.
"I do think we have to be careful," Harker said. He said the economy is "running on one very large engine — data center construction, and the power grid construction that comes with it. The rest of the economy seems to be coasting, not really doing much."
In the real economy, higher borrowing costs carry weight. New York Fed data show that credit card and auto loan delinquency rates have continued to climb in recent years. In the first quarter of this year, the credit card delinquency rate rose to its highest since 2011 and remained elevated in the second quarter. The housing market has been held back by mortgage rates — which have risen to their highest level in more than two years.
A Small Example of Those Hit by Rates
One person feeling the sting is Aurelius Chaves, president and owner of Midland Machinery, a road-building equipment manufacturer in Tonawanda, New York. He has had to cope with sharply rising costs, from employee health insurance to business insurance. When the Fed raises rates, the impact hits both his own loan costs and the equipment dealers who buy his products.
"My sales go through a dealer network, so when their costs rise, they start cutting inventory," Chaves said. "I know exactly how much more interest each 25 basis point rate hike will cost me next year."
For now, Chaves said overall business is still holding up, a sentiment echoed by other readings. The "Orange Book" compiled by institutional industry research found that in recent earnings calls, more than two-thirds of industries mentioned that the economic recovery is accelerating, with most attributing it to the AI investment boom.
Fed Chair Kevin Warsh cited this strength, attributing the central bank's recent rate hike decision in part to an optimistic outlook for accelerating growth. "Think about the geopolitical landscape with shocks and uncertainty intertwined, and you begin to appreciate the resilience of the US economy," Warsh told reporters on September 16.
If policymakers decide to raise rates again on October 28 — less than a week before the key midterm elections — Warsh's challenge will be how to package that message to the people who put him in this position. Although President Donald Trump has toned down his sharp criticism of the Fed, he made his attitude clear at Warsh's swearing-in ceremony in May.
"Unlike some of his predecessors, Kevin understands that when the economy is booming, that's a good thing," Trump said. "We don't have to go crazy. Just let it boom."
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