Market odds of a September increase in interest rates rose on Friday after a strong August jobs report, disappointing equity investors. They aren't alone.
Some Fed watchers think the Federal Reserve should not only hold rates steady, but use tools other than the federal-funds rate to curb high inflation and foster economic prosperity.
"A hike would be a policy mistake," Barry Knapp, director of research at Ironsides Macroeconomic, says.
Knapp says a rate hike would flatten the Treasury yield curve and reduce the primary source of today's economic growth-namely, spending on artificial intelligence infrastructure, much of which is financed with debt. He says higher short-term interest rates likely would widen the divide between higher- and lower-income households' spending, as well.
Higher rates could increase the pressure on small businesses, which have less purchasing power, flexibility, and access to financing, says Russ Brownback, BlackRock's deputy chief investment officer of global fixed income. Still, futures market odds rose to 60% on Friday that policymakers would lift the fed-funds rate by a quarter of a percentage point at the Sept. 15-16 Federal Open Market Committee meeting, according to the CME FedWatch tool.
The Trump administration has made no secret of its desire for lower interest rates, with Vice President JD Vance saying Thursday that inflation isn't a reason to increase rates right now. "We feel quite confident that if you look at the inflation numbers, if you look at the CPI [consumer price index] numbers, that it is proper and it is responsible for the Fed to lower interest rates," Vance told reporters. "We are doing a lot of things to try to keep those interest rates down, but it would be nice to have help from the Fed."
On Friday, President Donald Trump said the just-released August jobs report, which showed 162,000 nonfarm payroll additions and upward revisions to the June and July data, should push the Fed to lower interest rates. "The U.S.A. is a much stronger credit than it was just a short time ago. A strong country means a lower interest rate," Trump said on social media.
Trump said high interest rates put the U.S. at a "very unfair disadvantage," and that he would stop trade with countries with which the U.S. has a trade deficit if the Fed doesn't rates.
Knapp says there is no justification for a hike, adding that underlying inflation trends are cooling. He notes that the New York Fed's Multivariate Core Trend Inflation model-which measures inflation's persistence across 17 core sectors-measured 2.7% in July, down from 2.8% in June.
"There is some reasonable doubt leaning against the notion that a hike is sorely needed," wrote Steven Blitz, chief U.S. economist at TS Lombard. The release of the August CPI on Sept. 11, and to a lesser extent the producer price index on Sept. 10, will be key determinants of the Fed's monetary policy decision.
Knapp believes Fed Chairman Kevin Warsh should focus on reducing the central bank's $6.7 trillion balance sheet rather than lifting interest rates. The balance sheet remains at historically high levels, despite several years of quantitative tightening, or foregoing reinvestment of the proceeds when assets mature.
Term premiums, or the extra return investors demand for holding long-term bonds, have been steadily rising, which indicates the Fed can't afford to stretch the balance sheet further, writes Sonali Basak, chief investment strategist at iCapital. That leaves the fix, ultimately, in the hands of the Fed.
"Perhaps Chairman Warsh intends to clarify the policy-rebalancing strategy post-midterms, not wanting to risk discussing the bank capital plan until after the rule has been finalized, thereby providing political red meat for the anti-bankster Democrats," Knapp says.
But unless Warsh can dissuade the market from expecting a rate hike in mid-September, he risks "painting the FOMC into a corner," Knapp says.
Warsh has long championed a smaller Fed balance sheet, but affirmed in his Aug. 28 speech at the Fed's Jackson Hole summit that he believes short-term interest rates are the predominant tool with which to achieve the Fed's dual mandate of maximum employment and price stability. This suggests he doesn't currently view balance-sheet reduction as an alternative to interest-rate hikes, writes Aditya Bhave, U.S. economist at Bank of America Global Research.
"Unconventional policies to spur economic activity may suit genuine crises but should otherwise be used sparingly, if at all," Warsh said.
Some Fed watchers now express doubts about more conventional measures.
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