• Quarter-point increase in Fed Funds range: 3.75% to 4%.
• Vote unanimous to raise and majority see one more hike this year.
• Warsh took some starch out of stock market by implying more hikes coming.
• Is this the start of a policy mistake?
• Bottom line: Fed back in rate hike cycle; confirmed focus on inflation.  

Stability action

All 12 voters agreed to raise the Fed Funds target range by one-quarter of a percentage point today. This is the first increase following a three-year cutting cycle. Per Chairman Warsh’s less communication mantra, the press release was shorter than the last one. The release’s emphasis was on inflation, stating that the hike will “support a timelier return” to the committee’s 2% inflation goal.

The press release did acknowledge the steady job market and improving productivity.  

Finally

Like Powell before him, Chairman Warsh got the markets going during his Q&A session. He repeated several times that “inflation is too high and has been for too long.” He drove the point home by finally revealing that even the Fed does not think inflation is moving toward its 2% target.

We always argue that the Fed is too late when it acts; at least they acknowledge they are not making progress and need to do something different. We have been steadfast in our belief that slowing money supply growth would moderate inflation from late 2027 into 2028.

Warsh stated in his press conference that the Fed acted on its own; it was not pressured by markets. We think the bond market rates moving higher definitely played a role in the rate hike decision. The Chair made it clear that more rate hikes are coming. To hike a quarter point two months before an election when Core CPI is near 2.5% and Core PCE is at 3.3% seems unnecessary to us.

Who is affected? On one side are central banks around the world reacting to war energy shock. On the other side are U.S. consumers paying more for credit and mortgages. Watching both and feeling the effects are our business clients, whose floating interest rate costs just rose after already paying more for transport. Squeezing businesses and consumers when the inflation is coming from the outside feels like the beginning of a policy mistake. We recall the Too-Late Fed in 2001 reacting belatedly to oil price rises and pushing the economy into a recession. 

What’s next?

No change in the Committee’s economic views; they believe the economy is “expanding at a solid pace,” but that inflation is too high. We note they moved their 2% inflation target one year further out, to 2029.

After the press conference, markets are now pricing in multiple rate increases. By spring, futures markets expect the overnight average Fed Funds rate to be 4.55%, suggesting two more quarter-point increases.

Longer-term Treasury rates have climbed over three-quarters of a percentage point this year, dragging mortgage and consumer rates higher. Central banks around the world are dealing with localized inflation, mainly from diesel and fertilizer. These cost increases usually last a couple of years. More concerning is the rise in real (no inflation) rates, the difference between the advertised rate and inflation. For example, the U.S. Treasury 10-Note closed Wednesday at 5.02%. The latest Consumer Price Index reading hovers around 3.4%. That implies a difference of 1.62% for a real rate. However, market prices for real 10-year rates sit at 2.7% today, 1% higher.

Markets are telling Central Bankers and the Fed that long-term inflation is concerning but government debt levels are getting out of hand 

Summary

We do believe Warsh and the Fed are serious about running inflation down to their 2% goal. We doubt that can be achieved within their three-year timeline in today’s staff projections.

Bottom line: We think a steady economy and strong capital spending will carry economic growth well into 2027. Oil/diesel inflation will be solved over the next couple of years as capacity comes online. Our markers for a rate increase are unemployment falling to 4% and CPI inflation hitting 4%. Perhaps for once the Fed was early instead of late.

Please let us know how we can help you. 

Steve Orr is the Managing Director and Chief Investment Officer for Texas Capital Bank Private Wealth Advisors. Steve has earned the right to use the Chartered Financial Analyst and Chartered Market Technician designations. He holds a Bachelor of Arts in Economics from The University of Texas at Austin, a Master of Business Administration in Finance from Texas State University, and a Juris Doctor in Securities from St. Mary’s University School of Law. Follow him on X here. 

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