The Fed is almost guaranteed to raise interest rates by 0.25 percentage points to the 3.75% level this week, after Friday’s U.S. consumer price index report showed inflation at 3.4%, still above the central bank’s 2% target. The CME FedWatch futures market prices the chance of a hike at 88.5%.
For Fed Chair Kevin Warsh, the decision is now reputational as well as monetary. After making multiple speeches about taking inflation seriously, he must act or risk fresh questions about the Fed’s credibility. Matthew Ryan, head of market strategy at Ebury, said the strongest case for a hike rests on preserving the Fed’s inflation-fighting credibility. He added that standing still may be the bigger gamble.
If Warsh surprises markets by not raising rates, which is what President Trump wants, Paul Donovan of UBS said it risks reawakening accusations of being a 'sock puppet' and raising credibility questions. Donovan said that would require a risk premium in bond pricing, which would raise real borrowing costs for the government and the private sector, with implications for investment and trend growth.
The pressure is not limited to the central bank’s reputation. Diesel is at an all-time high of $6 a gallon, and oil has climbed to $107 per barrel. At the pump in the U.S., gasoline is $4.31 per gallon. Bank of America said diesel is the key real-economy pressure point because it affects shipping, trucking, agriculture, construction and mining.
That is the part Washington never seems to grasp soon enough: inflation is not an abstraction, and credibility is not free. When a central bank talks tough and then hesitates, the cost shows up in borrowing costs, investment decisions and the price of moving goods through the economy.
Capital rewards clear rules. If the Fed wants the market to believe it means what it says, it has to follow through when inflation is still running above target. Otherwise, the taxpayer, businesses and households all pay for the delay in the form of higher uncertainty and more expensive credit.