The Federal Reserve’s upcoming interest rate vote may ultimately be decided by just a few hundredths of a percentage point in inflation readings.
Investors are closely watching this week’s producer and consumer price index releases as critical inputs for the Fed’s September 16 policy decision.
Markets currently see the Fed leaning toward a hike, but conviction remains low, with pricing indicating only a 60% probability of a rate increase.
Krishna Guha, head of economics and central bank policy at Evercore ISI, said the outcome will depend heavily on both the data and how markets respond to it.
“The rate decision will then turn mostly on the inflation data but also to some degree on where market expectations settle post-release,” Guha said in a note.
Guha argued that if core PCE lands around 0.21% or 0.22%, that would tilt the FOMC toward a hold, while an implied 0.23% or 0.24% level “could well go to a hike.”
“This precision is ludicrous,” Guha said, underscoring just how narrow the margin separating a hold from a hike has become heading into next week’s vote.
The Fed’s preferred inflation gauge is the personal consumption expenditures price index, not the CPI or PPI data being released this week.
Information from both indexes will nonetheless be used to estimate the PCE level, which is released at the end of the month and directly informs policy calibration.
Economists surveyed by Dow Jones expect a headline PPI monthly increase of 0.4%, putting the annual rate at 5.3%, while the consensus for headline CPI is also 0.4% monthly with an annual rate of 3.4%.
Adding further complexity, the PCE reading will soon face revisions for key metrics that economists expect will shave a few tenths of a percent off inflation readings retroactively.
Chairman Kevin Warsh’s well-known reluctance to telegraph the Fed’s intentions in advance has left market participants scrambling to interpret every public statement for clues.
Warsh recently emphasized his displeasure that the Fed has missed its 2% inflation target for more than five consecutive years, remarks made at the annual Jackson Hole symposium in Wyoming.
Markets interpreted those comments as a signal that Warsh will push for a quarter percentage point hike when the committee votes September 16.
“With Warsh’s credibility under pressure, it will be tough to hold if the market prices a hike as clearly odds-on eve of the meeting,” Guha said.
Fed officials remain publicly divided, with Cleveland Fed President Beth Hammack pushing for hikes and Fed Governors Christopher Waller and Michael Barr advocating a more data-dependent approach alongside New York Fed President John Williams.
Former Cleveland Fed President Loretta Mester added her voice to the hawkish camp Tuesday, saying the Fed needs to hike to demonstrate its seriousness about inflation.
“I would really be arguing to raise rates,” Mester said in a CNBC interview, adding that Chair Warsh must clearly explain whatever decision the committee reaches at the post-meeting press conference.
Guha maintained that a hold remains fractionally more likely than a hike, citing expectations that inflation data will come in on the cooler side.
“Our working hypothesis overall, heading into the week, we still think a hold is fractionally more likely than a hike,” he said, noting the bar for holding has risen since Jackson Hole but remains achievable.
