Economists Expect Fed to Hold at 3.75%-4.00% This Week, All 100 Polled Forecast a December Hike

Since the Federal Open Market Committee voted 12-0 in September to raise rates by 25 basis points, the argument inside the markets has shifted from whether the Fed hikes again to when. The next test is the Oct. 27-28 meeting.

The federal funds rate currently sits at 3.75%-4.00%. In a Reuters poll of 100 economists taken Oct. 16-20, 94 expect the Fed to leave it there at that meeting. That matches market pricing.

December is where the consensus lives. All 100 respondents expect a hike at that meeting, a sharp reversal from fewer than half in the September poll.

Inflation data is the backdrop

The latest government price reports ran hot. Breitbart's weekly business wrap reported that the consumer price index rose 0.6% in a single month and the producer price index jumped 1.3%. It tied the CPI jump to gasoline above $4 a gallon, and said the reports showed inflation had spread beyond energy: core CPI rose 0.3% and services less energy services in CPI climbed 0.4%.

Oil is a live issue. Reuters reported that oil prices are holding above $100 as the war with Iran shows no signs of easing. It said the rising cost of living, driven by higher energy costs from the war as well as new tariffs on imported goods, is a key political vulnerability for Republicans ahead of the midterms.

The Reuters poll also shows the expected ceiling creeping up. Nearly 60% of forecasters see the policy rate peaking at 4.00%-4.25%. But 38 of 92 who answered that question predict at least two further increases, up from just one-fifth in the September survey.

Warsh is not giving signals

Fed Chair Kevin Warsh has made clear he is not keen on giving guidance, and he has kept mum on the next move. He spoke at the IMF and World Bank annual meetings in Bangkok on Oct. 16 without signaling a policy direction. "I don't prejudge meetings. I don't believe in saying now what I might do at the meetings we have in the balance of this year," Warsh said. "It's a new chapter at the Fed, and we're not in that business anymore."

Markets have filled the gap themselves. Breitbart reported that fed funds futures were pricing around a 72% chance of a hold this month before Warsh spoke and more than 85% afterward, as the market read his refusal to give guidance as confirming what it had already priced in.

Bond traders have been whipsawed. Longer-dated Treasury yields surged to multi-decade highs on Oct. 7 on higher inflation and near-term rate expectations, then retreated nearly 25 basis points as the likelihood of an October hike slipped away. Two-year Treasury note yields have also swung sharply higher, then lower.

Reuters reported that Fed officials have recently suggested they prefer a slower, more deliberate path for rates. That is the case for skipping October: the committee just raised rates in September, and Warsh has shown no appetite for rushing.

The case that the Fed is behind

Alex Pelle, senior U.S. economist at Mizuho Securities, rejects that patience. "You have a strong economy and you have inflation. There's really no reason for you to worry so much about getting interest rates higher, this is like the easiest choice," he said.

Pelle called a hold "the wrong call from a policy point of view." He said the Fed is "just treading water and perhaps even getting a little behind."

He also flagged a risk to the December consensus. "They'll go 25 in December, but the risk is greater they end up going 50 than they don't go at all," Pelle said.

Michael Gapen, chief U.S. economist at Morgan Stanley, said the risks point toward a Fed that ultimately needs to hike rates more than expected.

Breitbart went further, arguing a hike at the October meeting is "a lot more likely than people think," and that it would reinforce the Fed's credibility on price stability.

The political overlay

The meeting falls days before the November midterm elections. CNN's chief data analyst Harry Enten said on Oct. 15 that President Trump's approval on the economy has collapsed to the worst level for a president at this point in decades, and that prediction markets were signaling a chance of a Fed rate hike in December. CNN framed that as a major advantage for Democrats on the issue.

The Fed's stated posture, as reported by Reuters, is patience, and Warsh has said little beyond that.

What to watch

A hold is the overwhelming expectation among economists polled. The open question is whether the Fed says anything that confirms or breaks the December consensus. Warsh's refusal to give guidance has not stopped markets from reading his words as a signal, and the whipsaw in Treasury yields since Oct. 7 shows what happens when conflicting signals meet hot inflation data.