A Fed Rate Hike Is Likely, But 3 Major Questions Will Remain
How this plays out is far more complicated than ‘a hike is bad and a hold is good’ and will not be settled today.
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We have a mild bounce early Wednesday as investors await the Federal Reserve’s interest rate decision at 2 p.m. ET. Futures are edging up, the 10-year bond is just shy of 5.01% after crossing 5% this week, and Brent has slipped back below $108 after rising nearly 3% Tuesday.
The temptation is to treat the Fed decision today as a binary situation where a hike is bad and a hold is good. It is far more complicated than that, and it is likely to take a while for the market to sort out whatever does occur.
The hike itself is close to a certainty, at 92% odds, and the market has spent the past week pricing it in. The three things that are still murky are what actually determine how this plays out, and none of them will be settled by the announcement today.
Will the Hike Fix Anything?
The first question is whether a hike does anything about the inflation it is aimed at. The main drivers of inflation right now are energy and the AI buildout, and both are supply-side issues and not demand problems.
Oil is at multi-year highs with the Iran war escalating, and diesel just crossed $6 a gallon. The Houthis have now taken effective control of the Bab al-Mandeb chokepoint at the southern end of the Red Sea, which is the alternative route to Hormuz, so both of the main exits for Gulf oil are under hostile control. Iran met with China in Beijing today. This is a conflict that is drawing in the major world powers and is not winding down.
A rate hike is designed to work when the issue is demand. Higher rates slow economic growth and that cuts back demand. A hike does nothing about a supply issue. So the argument is that raising rates is the wrong tool for this problem. Even worse is that it can have the unintended consequence of slowing the parts of the economy that are already weak while the energy-driven inflation keeps running regardless. That is the policy-mistake argument. Be prepared to hear more about it if there is a hike today.
Are More Hikes Coming?
The second question is whether this is one hike or the start of a series, and this is where Fed Chair Warsh has changed the Fed guessing game. His predecessors used their public comments to steer expectations. He has refused to do that, which is the whole reason the uncertainty has been this high.
There is one place, however, where we will still have some guidance, and that is the dot-plot, the chart of where each official projects rates are going. With no verbal signals, the dots become the only forward guidance the market gets, and that makes them more important than they have been in years.
One hike and done is the reassuring outcome, and it could actually bring yields down by settling the question everyone is speculating about. A projection of several more hikes sends yields higher and takes stocks with them. That distinction, not the hike itself, is the key issue the market is waiting for at 2 p.m.
The Political Dimension
The third question is the political ramifications. President Trump spent last year demanding rate cuts and got three. His handpicked chair is now expected to hike, seven weeks before the midterm elections, which is exactly what the president does not want.
So far Warsh has avoided confrontation with Trump by saying little and avoiding direct provocation, which is a different approach than the one Jerome Powell took. A hike today is the first real test of whether that quieter approach will spare him the sustained public attacks Powell endured.
A Fed seen to be under political pressure will create greater uncertainty, especially with the election coming soon. The potential for additional volatility due to Trump’s reaction is substantial.
Game Plan
I am not making any bets on the outcome. The way the market has been acting recently, there is likely to be some search for relief but I am expecting some sharp swings as investors debate the repercussions of the news.
Betting on a Fed decision is not my style, and that goes double when the chair has made the guidance this opaque and the ramifications reach past economics into politics.
The market sold hard into this and bounced a little this morning, which is the nervous positioning you see before a binary event. Whatever happens at 2 p.m., the reaction over the following sessions will tell us more than the initial move, because the first read on a Fed decision is often wrong.
My buying power is ready and my shopping list is long, so I’ll be ready for whatever happens.
At the time of publication, Rev Shark had no positions in any securities mentioned.
