Why the Federal Reserve Raised Interest Rates

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1:57A lot of people thought that he would try to balance what the bond market was asking of him and what the president was asking of him by implying that he was just going to hike the once, that this was one and done. It seems that he has dealt with that issue and maintained his credibility in many important ways by, you know, he's given us a rationale for he's really quite comfortable hiking and without absolutely pre-committing to it, making it pretty clear that he's prepared to go further.

2:34I'm David Gura, and this is The Big Take from Bloomberg News. Today on the show, the Federal Reserve raises rates by 25 basis points, unanimously in the face of elevated inflation and elevated uncertainty. Bloomberg Opinions' John Authors is with me, along with Maria Eloisa Capuro, who covers the Fed for Bloomberg News. And the three of us are going to dig into the Fed's latest rate hike, the market reaction, and the political fallout.

3:06the plain fact is that inflation is too high and has been for too long john you wrote earlier this week that kevin warsh kind of walked into a rates trap yes explain what you meant by that i can't think of a cpi report that has had as much perceived importance as the one that we got last week this is one of the more plainly consequential ones and the irony is that Kevin Walsh has set out his stall against giving forward guidance, against boxing himself into corners. But the way he presented himself at Jackson Hole a few weeks ago, when he complained that inflation was too high, he made the point that the level of inflation is unacceptable.

3:50He didn't talk about the direction of travel. He wasn't talking about, are things steadily improving? He was saying, this is too high. And the problem he then had was that last week's, last month's report, the level is still too high, if you are serious about the Fed's target, because of oil. Thus, he's more or less boxed himself into hiking because of the framework he gave us only a couple of weeks ago and because credibility is so important. Maria Eloise, I saw you in Jackson Hole after that speech. Was it immediately evident to you when he delivered it that this trap had been set and indeed he was wandering into it?

4:31It was definitely something that we were asking people where they felt like caged in September. But I think it's useful also to take a few steps before that. And the reality is that there were members of the committee. This is not just Kevin Walsh. This is a committee for other people voting. There were already members of the committee who felt back in July that there was enough reason to hike. So we had three descents in favor of a quarter point hike. And at the same time, we've had most recently, even after the speech, other members of the committee also saying that they're very concerned about inflation, that if August came in hot, they would be willing to consider a hike.

5:14So it is pressure building also, I would say, like around him. In the sense of which, he also came to Jackson Hole very pressured to deliver or to explain his thinking a little bit more. Because he was so reluctant to do so. Exactly. And it's not, as John was saying, not just his reluctancy to give further guidance in terms of where interest rates are going. But he also wasn't given much of his thinking around anything on the economy. July's presser was very criticized. His answers to reporters were not very detailed into what is he thinking about inflation? Where is he seeing signs that concern him?

6:00What does he think about the employment? So I felt like he felt forced to be more direct. And he was. How direct was he in talking both about the rate hike and the rationale behind it? He was perhaps slightly more direct than he might have been. You could argue that he was arguing to a constituency of one, i.e. Donald Trump, in making it several times clear that this was because of the economy being stronger than people thought it was. and that geopolitics had moved against. But that was an interesting way to frame it, which he came up with several times. If you listened very carefully, he was saying that he was embracing a discipline rather than a decision.

6:48Last month in Wyoming, I expressed my commitment to a monetary policy discipline, not to a decision. So I think your average psychological profiler, if this was a thriller would say that he's giving the game away that he does indeed expect to hike further. And that's what the dot plot said today as well. The dot plot say that and Bloomberg's beautiful warp is now even clearer that we've got three more hikes after this one, four hikes total. This is going to be a true tightening cycle And that is a quite remarkable shift in a very swift period of time, which has been accompanied, I would argue, by a really quite surprisingly mild reaction in the stock market.

7:38And we go to the warp function, the world interest rate probability function, the Fed funds future rate function on the terminal and see. There was such conviction among investors that the Fed was going to raise rates today. 2 p.m., headline flashes on the terminal. I get up and look at you, John, across the newsroom. Your eyes, eagle eyes, glued to your worksheet, looking at the market reaction. Walk us through what you saw, what your takeaways were from the way that the market reacted to the decision today and the chairman's comments at the press conference. I mean, the most obvious reaction, which held up, was the dollar.

8:13Looks as though currency traders weren't expecting this hawkish a move. And I think the statement also similarly had more of an implication that they were going further than had initially been thought. And you did see higher rates, all other things equal, attract funds to where the higher rates to be had strengthen the dollar, all else equal. So the dollar was the one that most startled me and most interested me. The other thing that intrigued me, the stock market, we are below the peak. we're about three percentish below where the peak was we're still up 10 for the year uh if you ask me this is this was more hawkish than expected should therefore very directly mean that stocks should go down a bit and they did but they really didn't go down all that much um and that that was quite interesting there were moments during the press conference when uh when the stock market seemed to be getting more nervous but you're still down 0.5 for the the day after plainly more hawkish worse for stocks than expected announcements suggests basically that we can handle this that that kevin walsh is right when he says he finds it hard to say that conditions are restrictive at the moment he can he's just hiked rates and the stock market is still very close to a really impressive all-time high john let's talk about how we got here.

9:45Just give us the 30 ,000 foot view of how this economy is doing now, what the data are telling us and policymakers about jobs and inflation as well. Well, we've got to bear in mind that this is with looking at the economy in the aggregate, but at the aggregate level, particularly thanks to the unexpected positive shock coming from all the money being spent on AI, there's no great positive shock from productivity helped by it yet, but there plainly is a very big positive shock from the sheer amount of money being spent on building it out. The economy is fine. Nominal GDP is rising at levels that's outside of the really big distortions around the pandemic we haven't seen in 20 odd years since before the global financial crisis and didn't really very often see grow any faster than this for the 10 years before that, which given that the economy is that much bigger these days, starting from a higher base, that's a good place to be.

10:42If you look at financial conditions, Bloomberg has lots of very cunning ways of smooshing together lots of different measures of exactly how tight money is. Financial conditions are pretty much as easy as they have ever been since we've been measuring them, which again goes back some decades. So there is no way on earth that you cannot survive one a pathetic little 25 basis point rise in the Fed funds rate. Companies are raising money with no problem at all. And where there is at least some reason to think that inflation is higher than ideal and that it's worth taking some steps to reduce it, particularly given that there is a very serious problem with inequality, which is very directly worsened when inflation is high.

11:34ergo from 30 ,000 feet there's an argument for rates to be somewhat higher than they are now

11:42after the break more of my conversation with john authors and maria eloisa capuro

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14:41So, John, in that trap that you described, there were the political pressures that Kevin Warsh is under. And then there's this other mechanism, this other part of the trap, which focuses on sort of the way that the market is responding. And Warsh talked about referees and players and the like here back in July. Are you surprised by the degree to which that market mechanism has him most caged in right now? I am a little. I mean, he was it was the World Cup was on. Lots of Americans suddenly discovered the world's game. Which we already know. You both do. Our experience in Latin America. Europeans and English people obviously know what it's like to win the World Cup, unlike Americans.

15:17We won it four times. Brutal. According to the FIFA. We digress. We digress into subjects which may or may not interest us even more than monetary policy. I think the trap is we are in this very difficult situation. There are two important points. One is Donald Trump has been prepared to take much more direct action against Jay Powell than any president had done in previous history against a Fed's chairman. Jay Powell's still a governor. He is still a governor. There are limits to what he could do, but plainly he can make your personal life very difficult. And Lisa Cook could tell you this as well.

15:54The other thing is at this point, and this could actually surprisingly point to how important the midterms turn out to be. Walsh's term lasts longer than Trump's. Unless you can find a way to actually fire him, which we discovered with Jay Powell is pretty difficult, he can just outlast this guy now. And a lot could depend on the midterms. If this is a really major blue wave rebuke to Trumpism, which is possible, then Trump can huff and puff a lot more and we have a more truly independent Fed chair. If it turns out, and again, I regard this as about equally likely to the big blue wave, that he barely loses the House, holds onto the Senate quite comfortably, quite a number of big Trumpy politicians actually get back in, and you still have a fairly empowered president with the Senate behind him for another two years, even if he's a lamer duck than he was, that could make quite a big difference to the politics of exactly how Kevin Walsh is able to do his business, exactly how independent he can be.

17:02And to add, even though the Fed remains independent from economic cycles, and I do feel all of the Fed officials do think about the economy independently from economic cycles, the reality is that if the situation gets worse in inflation and they didn't hike now, what could have happened in October? Like, are they actually free to hike in October? Like, is the next rate hike most likely coming in December still? Because of the election. Because of the election cycle. There are studies that do actually show that central bankers pressed into political cycles to at least intend to weigh them out and not make drastic calls before elections.

17:51There's certainly a very widespread belief, which I can tell you just from my inbox. There was the jumbo cut that Jay Powell made of 50 basis points the September before the 2024 election. And if you could remove the election from it and I could completely explain, it was a contentious decision, but I could completely explain it. They very nearly had cut the meeting before and they'd had some surprisingly bad data like two days after they had met and realised they should have cut then and they were catching up. There were good explanations for why they suddenly cut by 50 bips with an election coming up.

18:29That looked bad. It's not stupid. It is not mad conspiracy theorism to think that was out of order and that has definitely heightened tensions. You do not, if you're Kevin Walsh, wants to be on the receiving end of people angrily thinking you are playing politics. So we got the market reactions we've been talking about, and then the anticipated reaction from the president as well. He posted on Truth Social after the meeting and the press conference, interest rates in the United States should be 1 % or less because we are the best credit in the world by far. He goes on to say at the end of that post, lower the interest rates for the United States of America and FAST, all caps with an exclamation mark at the end.

19:12What does this mean for Kevin Walsh as he is still navigating this new job. To some extent, as I've been saying earlier, unless he's prepared to go to the lengths of actually trying to fire Kevin Walsh for cause, or get the Justice Department to come up with some reason to prosecute him as an individual, both of which unfortunately are conceivable but are unlikely i don't think famous last words i'm not sure what donald trump says about this for now matters all that much he made his call he gave wash the job he stuck with him and he can he can huff and puff but i don't think that would move the market terribly unless he did something as extreme as i just said unless he actually makes a coherent attempt to fire the guy.

20:08That would be huge and it would be very misguided. I think there's also ways in which maybe we get a more tame reaction than we feared from the White House. But if they can sell it as it is appearing to be a decision to initiate a rates hike cycle that may be a short one, because really there's two more rate hikes implied in the dot plot that sort of corrects and, you know, removes the dose of accommodation that the chairman Walsh was saying today and helps drive strength in the economy, as he also said. We removed a dose of accommodation so that financial and credit conditions would be more consistent with our ultimate objectives.

21:03But for everyone, as he also said, that inflation, it is a tax on those who have, on those lower income households. Yes. If he can sell it that way, I think we may have a more mild reaction and he survives. One other point I'd add to that, I think Kevin Walsh was, he's quite a good politician, Kevin Walsh. He did sell this as the economy is stronger than I thought it was when I arrived 120 days ago. The phenomenal Trump economy is just so good that we just have to tighten rates just a little bit and it isn't going to hurt. It's because we're just so strong. This is The Big Take from Bloomberg News.

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