Instant Reaction: The Fed Decides

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1:29Bloomberg Audio Studios, podcasts, radio, news. This is a breaking news update from Bloomberg. Instant reaction and analysis from our 3 ,000 journalists and analysts around the world. Down in Washington, D.C., from the nation's capital, is Mike McKee. It is a rate increase, the first of a cycle, a unanimous decision to raise their benchmark rate A quarter point to three and three quarters to four percent. Sixteen members of the committee anticipate another increase this year. Only two would hold here. Kevin Warsh, the chairman, does not submit a dot. Eight, almost half, see another increase, another rate increase next year, while six call for no change.

2:16Four see rate cuts in 2027. One of them calls for rates to fall to three and a quarter percent. Almost as significant, they raised their long-run view, essentially the neutral rate, to 3.2 % from 3.1 % in June. The members see faster growth this year and next, 2.3 % and 2.4%, up a tenth each from their June forecasts. And the economic activity, the statement says, is expanding at a solid pace. unemployment is forecast to remain at 4.1 percent this year and hold at that level through 2029. Job gains, the statement says, have kept pace with the workforce and the unemployment rate has changed little.

3:00Inflation, though, according to the statement, remains elevated. The median outlook is seen higher this year. PCE headline at 3.7 percent, up from 3.6 percent in June. Next year, it falls to 2.3 percent. Achieving the 2 percent target gets pushed out as usual two years to 2029 now. Core PCE will be 3.4 percent at the end of 2026, up a tenth. Next year, it's two and a half percent unchanged. The statement concludes today's policy action will support a timelier return to the committee's 2 percent goal. The committee will deliver price stability. Mike McKee, thank you, sir. You stay close. Let's go through the price section.

3:43Bonds advancing into the decision. We give only just a little bit of that up. Yields are lower by two basis points at a front end. Tues at 464. On tens this afternoon, we're down by 5 to 495. Earlier in the week, of course, breaching 5%, a number, a level we haven't seen going all the way back to 2007, at least earlier this week. In the equity market this afternoon on the S &P 500, on the Nasdaq, on small caps, the Russell, we still advance. We're still just about positive, though we're off session highs, up by 0.2 percent on the S &P. The question for the chairman in this news conference, was this a one-off tweak?

4:15Is it high for longer or higher for longer? Is it the start of something more than just 25? The word that I think is going to be analyzed and overanalyzed will be timelier, a timelier return to 2 percent inflation. The median forecast in the Statement of Economic Projections, granted it did not include Fed Chair Kevin Warsh, includes an additional 25 basis point hike this year. And as Mike was saying, a higher long-term neutral rate. All of this speaks to the idea that this is part of a cycle. This is not a one-off. And that this is a Fed that has run out of patience. The unanimous decision, Bob Michael nailed that, was a big tell given how many people got on board, including the Fed Chair himself.

4:55I'm absolutely fascinated by the labor call, which I know is off the radar right now. But they don't look for any change in the labor economy. It seems to me they're looking at output to be good and not problematic. This is all going to get solved gloriously by inflation coming down and output will be fine. Says who? And that's to me the huge mystery here. Neil Dutter of Renmack, the first to respond in my inbox, reads as follows. The Fed is not done. The odds are they are underestimating just how much work they need to do. That also explains the gap between the policy rate even now this afternoon and where the two year is currently, because the two year is materially higher than the policy rate.

5:32Ultimately, do they close the gap of 100 basis points? And what direction will that gap be if the Fed is further behind the curve than they realize? Then is the goal here, given the timelier return to 2 percent inflation, is the goal here to get there more quickly and to take out some of the dynamism that we have seen in, frankly, capital markets, as well as just overall growth. With Vice Chairman Clarita coming on, his colleague Ned Phelps, late Ned Phelps at Columbia, that's his favorite word, dynamism. I don't hear anything within the comments of Mike McKee where there's any planning for a slowdown in the American economy right now with half of America basically flat on their back from whatever reason.

6:14Don't see much of that in the forecast. Mike McKee is still standing by before he runs into that news conference. Mike, what would you point to in the forecast, the projection materials that might set the tone for the news conference in 25 minutes time. Well, one of the interesting things is they say that this move will result in a timelier move to the 2 % target. And yet they push the 2 % target out another two years, as they almost always do with these summaries of economic projections to 2029. So I'm not sure what timelier means in this case. They also do acknowledge that inflation is higher.

6:47And I think the move up in the long run neutral rate is important because they've been talking about that as a possibility because of AI and the spending on AI. And that could mean that we're in a higher for longer kind of environment, a new regime, as it were, for interest rates. And we've seen that in real rates, echoing the idea that the neutral rate is higher. Mike, thank you, sir. Looking forward to your question in the news conference a little bit later on this afternoon, that news conference at 2.30 Eastern time. Just to put on what Mike was talking about, the projections for, let's say, core PCE.

7:22Let's take core PCE. That's a 3.4 for 26 compared to the June projection of 3.3. For next year, 2.5. The June projection was 2.5. For the year after Bramow, 2.2. The June projection was 2.1. It is an important question. You're saying one thing about a timely return to target, and then you look at the forecast, and it's not really there, is it? Yeah. How much are other people on board with this, number one? And is it timely as compared to what? As compared to how much more you see inflation potentially accelerating, considering that it's moving in the wrong direction? I also think they still see unemployment declining in terms of the unemployment rate over this period of time.

7:57So economic growth clearly not part of the equation, not a problem to hold them back from additional rate hikes. Again, I am curious how unified this FOMC committee really is, given some of the rhetoric we've heard. So bring in the speeches that we're going to be hearing over the next couple of weeks. I think, you know, you look at the unanimous decision, and maybe that to me is the headline here, is they listen to Bramow. It was bad form. They listen to you. Don't dissent. Yeah. Stay out of trouble. Don't dissent. That's the right phrase. Stay out of trouble. Get to the next meeting and then keep your head down for the elections.

8:28Let's talk to a man who's been there, done that. The former Fed vice chair, Rich Clarida, joins us now for more. Rich, welcome. Not a surprise to see 25 basis points. What would you point to that is the key development this afternoon? Well, I think Mike McKee, as usual, did a great job. You know, the timelier language is noteworthy. But again, the mission accomplished is pushed out two years. I think it is important that it was a unanimous decision. I think it's also relevant that you had 16 people, and I would also count 16 of the dots, and I would count Chairman Worsh. You had 17 folks indicating, I think, another rate hike later this year, which had been our call, that this would not be one and done.

9:10And they give a very firm signal. They may not need to do more. I actually think the 3.4 percent on core PCE, which is what I think I heard Mike say, I think is a little lofty. I think we could come in below that, especially given some of the methodology revisions. So but, yeah, I think important that was unanimous decision and a clear, overwhelming majority of folks think they need to move at least once more, which is in line with what we think as well. Rich, what do you think changed so much from the July meeting to today that caused a unanimous decision by all of the members, the voting members, to hike rates and potentially engage in a cycle, not just one and done?

9:53Well, the history is, Lisa, is that we typically don't see one and done. And so I think that's relevant. You can think about it. If we're targeting our target by more than 100 basis points, what is 25 basis points on rates going to do for that? So I think there's a credibility to our staff, that's a very specific communication guide, Williams and Waller and others saying, look, we want to see progress. I think Williams put out their 0.2 per month on core. And since then, we haven't got 0.2 per month on core, especially given where I think we're going to end up with the core reading later this month.

10:31And so I think they wanted to see that progress. I think Chris Waller said give disinflation a chance, and they hadn't seen it. So I think, especially after Jackson Hole, it was important to ratify that reaction function. Richard Clareta, your acclaimed research on dynamic, stochastic, general equilibrium theory. The word stochastic is for shocks. I didn't hear any statement on shocks coming from Michael McKee, and yet they have to live with the shocks at present. Who's right, Waller or Warsh, on shocks and the importance of them forward?

11:08Chris Waller and Chairman Warsh understand and are focused on the shocks. In fact, I think that was one of the big questions that the chairman is wanting to try to answer. So I don't think the committee is disagreeing. I think it's more how persistent will these shocks be? Are we going to be talking about higher memory chip prices a year from now? Now, where were where were tariffs and, you know, the oil futures curve has been.

11:38But get oil prices. And so I think it's not so much shocks or no shocks. It's how persistent are they going to be? How much further will they go? And are they willing to go the final mile? Are they willing to go through the pain to get inflation back down to target? had a message from a Bloomberg subscriber just moments ago, and that's the question they're asking. Is this Fed willing to go through the economic slump that might be required to get inflation back to target? Because so far, right now, inflation has been above target for quite a while. Based on the fact that equities are up, I would say the answer to that right now is perceived to be no, that ultimately they will stop short of engineering a full-blown recession because of the reluctance to do so.

12:22And so that is why you're not seeing four, five, or even six rate hikes getting penciled in by anybody. That said, there is a lack of understanding of just how much inflationary pressure and how much growth there is in this economy. It has surprised analyst after analyst after economist. And at what point do we end up seeing that come through in the Fed having to go further than they thought? Dan Swankov, KPMG, standing by to jump into the conversation as well. Dan, welcome to the program. We've got a hike. They're looking for another one. There's a market lean and a lean on the committee to go maybe even further than that, Diane.

12:53What What are you expecting beyond just 25? Well, one of the things that I think is really important is this is the beginning of a rate hiking cycle. They've signaled two already. That's important. And they don't want to get ahead of themselves because they're managing to the economic aggregates. We've got an economy that's resilient, but not resonating with too many. And I think that's important as well. At the end of the day, though, their job is to derail inflation. And if we get into 2027 and we're still seeing stickiness, particularly in the service sector and the dispersion of prices, that's going to be a real issue for the Fed.

13:32And they'll have to go further. And then we'll have to see just how much they're willing to derail growth versus higher for longer and hope for a softer landing. One thing that I thought was notable, Diane, is that in the statement, they do refer to geopolitical developments in passing. They say, well, uncertainty due to geopolitical developments has been ongoing. Domestic spending has been resilient, a nod almost to the retail sales that we got earlier today. How much are they not really going to address the oil price shock because of these strong economic data elsewhere? In other words, supply side shocks are fair game as long as they come with strength in other places.

14:13Well, it really is. At the end of the day, we had the retail sales today and they were stunningly strong and broad-based. Some of those retail sales reflect actually buying ahead of feared increases in tariffs in the vehicle sector, but they weren't all that. And that is, of course, the very behavior that the Fed is tasked to avert. So I really think it is a combination of demand and supply shocks that they're dealing with now. And they're acknowledging that with more than one rate hike in their forecast. Diane Swank, your academics is Michigan, and Michigan has been fabulous in the study of inflation.

14:50What I hear is some guess that we can bring down inflation and not bring down real GDP. Can we have that nirvana or is that just naive? I think it's more naive than nirvana and I am worried and I tell you all the economists that I'm talking to on the industry level, all the industry economists that I talk to, they are worried about the cost pressures they see in the pipeline and that it will be much more sustained. And what will it take to really derail this inflation? So right now, this is a step in the right direction. But the debate within the economics community is starting to be not whether or not they have to raise again.

15:32But how many rate hikes do we need and how much do we need to suffer between here and price stability to get to price stability? Perfectly said. John Farrow, it's as simple as this. Is that debate happening at the Fed? or are they walking on eggshells because of 1600 Pennsylvania Avenue? Well, I think they're certainly having that debate. And the White House is having no influence over this conversation because they've just hiked race by 25 basis points and signaled they're willing to go again. Dan, I just want to build on this conversation you're having because I think it's so, so important. Do you believe this labor market is tight enough to put up the wage growth that would support these higher prices?

16:08Do you believe the consumer price tolerance exists to pass on these higher prices? Do you think we're in that situation now?

16:20In terms of the labor market right now, I'm seeing two labor markets at the same time. There's pockets of labor shortages where wages are starting to pick up. I was just talking to a bank CEO yesterday who said all his clients can't find workers at the entry level. These are not new college grads. These are entry-level positions that once might have been filled by foreign-born workers that are not being filled today. and that's putting upward pressure on wages there. On the higher level, we just saw some economic research that showed those professions that are most exposed to AI are seeing a slowdown in their wage gains.

16:57We're not seeing job losses per se from AI, but we are seeing a slowdown in wage gains in those sectors most exposed. And so you have this dichotomy that the Fed is trying to deal with. And the bottom line is, again, they can only deal with the economic aggregates. They can't deal with the inequalities and the unevenness of this expansion, which has gotten extremely concentrated in the AI build out as well. We just got a message from Steve Chivarone, a federated Hermes, the chief investment officer there. And he had this comment that I think is really important, Diane. If Warsh characterizes this as a recalibration to higher neutral rate, reflecting higher nominal growth, he can land the plane.

17:38Do you think that we're going to get that much, Diane, or do you think that ultimately we're going to have another exercise in letting the action speak for themselves? Well, I think that we're probably going to have to go through many iterations on markets on this, and I think it's going to be hard for the Federal Reserve. This, I think, the move up in the neutral rate, I expected that, but it's still too low. I actually think this is neutral what we're at right now. And that means we're way too accommodative at the moment. That's a very different perspective than what they just put out in the summary of economic projections.

18:13Diane Swamp, a simple question. Will you miss the dots if they do away with the dots?

18:22Would I care if they do away with the dots? Would you miss the dots? I actually, you know, the dots are, they're the dots. They give us an inclination that they're in a rate hiking cycle. I think the verbiage in the statement itself basically gave us already that we're in a rate hiking cycle. If it's one, it's more than one. As I agree with Rich, we actually have two more additional rate hikes and it could be more than that. And I think that's the important thing that we should be focusing on is they actually even changed the statement on this one. Dan Swank, KPMG. Dan, thank you. Appreciate it.

18:57If you did not have the dots today, I think we'd have a slightly different conversation because you wouldn't really know what was implied in the forecast at all. There wouldn't be any forecasts. We wouldn't be having that conversation about what comes next. We'd be pretty blind at the moment. And I'm not sure the Fed chair is going to give you much in this news conference either based on recent performances at the presser. Yeah, what we have is an imperfect measure of a cycle, not necessarily a one and done, which is incredibly rare. And that is ratifying market expectations. You're right. Without that, what would this Fed chair do, given the fact that he doesn't want to really give it to us verbally?

19:27At a certain point, though, you start to wonder whether the jury has come back with respect to a reaction function, necessarily forward guidance, to say that when you don't tell people, they price in an extra premia to offset the chance of a Fed that moves less predictably than some people were expecting. I look at the set of things that come into this mystery meeting we're having today, and I really didn't expect a Fed looking for nirvana of, yeah, we can do this. inflation is going to come in and there'll be almost a painless growth side is what I see. And I don't I did not hear from Diane Swank the idea that would be a successful outcome.

20:00I certainly hope they can. We hope to. Absolutely. I think we've all got a bias here. It's a good economy and I hope they can land that plane. The evidence of the last five years, though, Tom, is it's tremendously difficult to get inflation back to target with nominal GDP this hot and with the crude story in the mix, too. And this is the problem that many people will have with this hike this afternoon. This Federal Reserve can't print molecules. It can't print barrels of crude. It can't build refineries. It can't sign peace accords. There is nothing they can do about the situation in the Middle East.

20:28And I know we've been above target for a long time before this war even started. But without this war, without the shock and energy prices, we wouldn't be having this conversation about hikes of the ECB. I don't think we'd be having this conversation about additional hikes of the Federal Reserve either. I know you want to get to Matt Lozetti here, but I think this is important. Dominic Constant with a brilliant research note from Mizzou. and he partitioned Waller and Warsh and said there's not enough discussion about shocks and what they mean for the economy. And of course, from an institution like this, we're not going to get a shock discussion today.

21:01I get that. That's fair game. But the idea here of how these shocks play out is far more important than the dialogue I'm hearing today. I wanted to give the former Fed Chair of the Federal Reserve just a final word on the conversation we're having. Rich Clarrid is still standing by. Rich, thanks for your patience, sir. I know we had a technical problem on our end just moments ago. Rich, in your opinion, do you think we can get inflation back to target at this Federal Reserve without causing demand destruction in this economy? I do. We saw an example of disinflation without a recession between 2022 and 2024 and five.

21:38I think it can happen. I think, to be blunt, I think the PCE price index is overstating underlying inflation in the economy. If you look at the labor market, if you look at the CPI, inflation's above target, but it's not as far above target as the PCE is showing. Some of that may get revised away in a couple of weeks. So, yes, I think it's possible. We've seen it before, and I think it's certainly something that can happen again. Can the chair entertain that discussion without damaging its credibility? Well, it'll be interesting to see how Chairman Warsh navigates today. He may get that question.

22:15I'm eager to hear what he says. But yes, I think there's an affirmative case that one can make that, as I said, I think the PCE index is overstating underlying inflation. I think they have less ground to cover than maybe some of the indicators suggest. So I'll be interested to see if he makes that argument. He chose not to at Jackson Hole, but we'll see if he does make that argument. Watch this space. That news conference begins in 10 minutes time. The former Fed vice chair, Richard Clarida, they're weighing in on a decision, a 25 basis point hike. The forecast implying one more to go for this year and a lean, as many people have indicated this afternoon in their research notes, that there might be more to come in 2027.

22:52It wasn't just core PCE. If you look at core CPI, which is essentially that classic consumer price index stripped out of energy and food, you can see that it was 0 % in June month over month, 0.2 % in July and 0.3 % in August in terms of the increase. It is broad-based. That, I think, is the reason why people are saying they're taking action. Matt Lozetti of Deutsche Bank standing by. Matt, welcome to the program. Before this, you said this. It is not clear the Fed is sufficiently restrictive. We now expect the Fed to deliver 75 basis points of tightening in total. We've had 25. Do you believe they validated the other 50 with this this afternoon?

23:29Yeah, I think the dot plot was a little bit more hawkish than I was anticipating. I think you've got strong consensus for at least two rate hikes this year. 16 out of the 18 dots expect at least two rate hikes this year. And actually, it's a committee that's pretty closely split on whether or not you have two or three rate hikes in total for next year. I think that there's eight dots that show the Fed funds rate 75 basis points above yesterday's levels through the end of next year. So I think it's very much in line with our view at this point, which is that the Fed has started a mild tightening cycle and that it's a pretty strong base case that the Fed is likely they to take back the 75 basis points of reductions that they gave us last year.