- The Federal Reserve is navigating an economy as complex as at any time outside of a crisis, according to a Bloomberg weekend essay. Consumer spending is strong but sentiment is weak, bond yields are at their highest in decades yet stocks have soared, and growth is accelerating despite an energy shock.
- The Fed raised rates in September for the first time in three years, and the federal funds rate range now stands at 3.75%-4%. Investors are betting the next move is likely in December.
- The Fed has missed its 2% inflation target for more than five years. Since the end of 2019, groceries have risen around 30%, electricity costs 43% and car insurance almost 50%.
- Diesel prices are around 70% higher and gasoline around 50% higher since the Iran war began in February. Toy prices in September had their biggest annual increase since 1988, as tariffs on goods remain at the highest level in decades.
What Happened?
Bloomberg’s essay laid out the competing arguments facing Chairman Kevin Warsh and his colleagues as they weigh further rate hikes. Purists say the Fed needs to raise borrowing costs to a level that removes inflation from the system, which would probably mean landing above the current 3.75%-4% range. Others urge caution, arguing inflation is expected to slow sharply next year and that rising bond yields and higher borrowing costs would hurt lower-income workers and small businesses. The balance of signaling from policymakers ahead of this month’s rate decision suggests they have time to assess the economy before deciding whether to hike again.
Why It Matters?
Some of the biggest forces in the economy, from the AI buildout to shipping disruption through the Strait of Hormuz, may be beyond the reach of interest rates. Barclays analysis found hyperscalers are spending more than 90% of their operating cash flow on AI infrastructure, meaning at least that portion of spending would be insulated from rate hikes. The AI boom is expected to lift productivity eventually, but for now the cost of building the infrastructure is driving up borrowing costs and the price of computers. Fed officials remain haunted by the pandemic era, when calling inflation “transitory” left them behind the curve.
What’s Next?
The next test is this month’s rate decision, where signaling suggests officials are in no rush, with markets eyeing December for the next move. Political pressure remains a factor, as President Donald Trump keeps calling for lower rates and has revived attempts to dismiss Governor Lisa Cook. Former IMF chief economist Maurice Obstfeld argued the Fed should keep hiking until inflation is cured, likening it to finishing a course of antibiotics. Investors will watch upcoming consumer and producer price data for signs of whether price pressures are broadening or easing.
Affected Tickers and Coins: TLT, SPY, AAPL
Source: Bloomberg
