Is the “87% interest rate hike” or a market misjudgment? Agency: The Federal Reserve may remain on hold this week

The Zhitong Finance App learned that Michael R. Strand, director of economic policy research and senior researcher at the American Enterprise Research Institute, said that although financial market pricing shows a high probability of interest rate hikes, it is unlikely that the Federal Reserve will raise interest rates at the September meeting.

Strand said that the “focus” of the Federal Open Market Committee (FOMC) still favors keeping interest rates unchanged at the July meeting, and he doesn't think the economic data released since then is strong enough to substantially change this view.

Strand acknowledged that the August Consumer Price Index (CPI) report may prompt some FOMC members to support interest rate hikes, but he believes that the data needs to be clearly more worrying in order to push the Federal Reserve to start a new cycle of interest rate hikes.

He pointed out that the probability of raising interest rates in the market is 87%, but the proper question is not whether the Federal Reserve should raise interest rates this week, but whether it should start a cycle of rate hikes.

He added that the possibility of a one-time rate hike would present a separate communication challenge for Chairman Walsh, who may be unwilling to explain why the Federal Reserve implemented the first isolated rate hike in decades.

Strand said that at the same time, the August inflation data may not be as worrying as the market reaction shows. Based on the CPI report, he expects core PCE inflation to accelerate in August compared to June and July, but it will still be around 3.1% annualized. The six-month change in core PCE will be about 3.2% annualized.

If these estimates hold true, Strand believes that most FOMC members may still think that the data is in line with continued de-inflation, rather than a substantial re-acceleration of inflation. The CPI for core services in August was 3% year over year, the same as in July, and there is little evidence that basic services inflation has accelerated again.

Strand also believes that financial conditions have been tightened in the past few weeks and may have completed some of the work that originally required higher federal funds interest rates.

He said that although avoiding a negative market reaction may be one of the considerations of policy makers, the one-time interest rate hike itself will be contrary to market expectations, and the probability of two or more interest rate hikes in the bond market in 2026 is about 75%.

Therefore, unless the Federal Reserve intends to show that the policy approach under Walsh will be different from that of its recent predecessor, interest rate hikes may still surprise the market.

Although Strand expects the Federal Reserve to keep interest rates unchanged this week, he said he is personally inclined to raise interest rates. He believes that the federal funds rate is too low, and that he will vote for interest rate hikes in July, and also opposes the Federal Reserve's interest rate cut in 2025.

However, he doesn't think most FOMC members have substantially changed their assessments since July, so he expects the Fed to keep interest rates unchanged this week, while admitting that he “won't be shocked” if the Fed eventually raises interest rates.