I. The Fed Has More Work To Do
On October 26, we warned that the Fed could surprise markets with a 25bps rate hike at its October meeting. If the Fed chose to pass on doing so because the midterm elections were too close, we predicted a 50bps hike in December. Two days later, the FOMC voted 10-2 to hold the federal funds rate (FFR) at 3.75%-4.00%, with the two dissenters favoring a 25bps hike. Yet, in his October 28 presser, Fed Chair Kevin Warsh's assessment of the economy sounded decidedly hawkish. Economic growth was robust and broadening, the labor market was in good shape, inflation remained above the Fed's 2% target, and financial conditions were hardly tight.
So why did the Fed stand pat?
Warsh argued that financial conditions had tightened, inflation expectations remained anchored, and stronger productivity growth was allowing the economy to expand without overheating. With an information-rich period ahead, the Fed saw little reason to rush. We called that decision puzzling, comparing it to someone standing in a room with a fire alarm blaring and smoke pouring under the door, yet insisting on more evidence before calling the fire department.
Now Fed Governor Christopher Waller is sounding the same alarm. Speaking in London on Tuesday, Waller said he would support a 25bps rate hike in December even if inflation improved in October. However, if October's core CPI increased by around 0.3% m/m or more, as it had in the previous two months, he argued that a larger move would be warranted. Specifically, he said that "a 50 basis point hike in the policy rate should be considered at the December meeting." Waller warned that moving by only 25bps under those circumstances would jeopardize the Fed's inflation-fighting credibility.
