The Federal Reserve announced Wednesday that it would not hike rates this month. Is the war on inflation over?
Not by a long shot. While the Fed's move was widely anticipated by economists and markets—the jury's still out on whether another rate hike is on tap for Nov. 1.
"There's still some pressure on them to hike later this year," said Brian Henderson, chief investment officer at BOK Financial®. "The longer the economy is able to remain this strong, even with these higher interest rates, it's going to put in doubt whether the Fed is doing enough to bring inflation down. But that doesn't necessarily mean the Fed has to keep hiking rates until inflation gets to 2%, either. Keeping rates at this level or slightly higher can bring inflation down to that point, but to ensure we're on the right track, month-over-month readings have to keep trending downward."
The latest Federal Open Market Committee (FOMC) decision is only the second time the Fed has decided to skip hiking rates since March 2022, and we've been in one of the most aggressive rate hiking cycles we've ever seen, Henderson said.
So, will the Fed keep rates higher for longer, or raise rates even higher than expected? One thing to consider: the latest inflation data was higher than expected, with the Consumer Price Index (CPI) rising 0.6% in August.
We asked Henderson to dissect what's happening in the economy, the latest Fed moves and what may be ahead:
What needs to happen for the Fed to take more rate hikes completely off the table?
Henderson: In general, the Federal Reserve is trying to set monetary policy at a level that the overall demand for goods and services is in balance with the goods and services that are available, resulting in 2% inflation. However, it's not just getting to 2%; they need to have that balance in place so they can sustain it.
So, are we at a level where we can achieve that balance? No, not today. Monetary policy might be close to where it needs to be, but the current inflation data shows that the conditions are not quite there.
One factor is wages, which are a big component of services inflation. [This includes the cost of eating out at restaurants, transportation and medical care.] The supply of labor is very low right now, with only a 3.8% unemployment rate in August, and though the demand for workers has slowed somewhat, as the number of job openings has dropped, the labor market still remains pretty strong, which helps keep inflation elevated.
What makes the Fed's decisions to skip rate hikes during this rate-hiking cycle different from the stop-and-go approach of the late 1970s/early 1980s?
Henderson: As the Dallas Fed President Lorie K. Logan has said, pausing isn't stopping. The Fed has only skipped rate hikes at two meetings after hiking very aggressively to get rates at what's considered a restrictive level, and they have one more rate hike planned for this year.
In the late '70s , they hiked rates aggressively but then flipped and cut rates dramatically—and they did that in an environment when we weren't even in a recession. Shortly after they cut rates, the economy and inflation reaccelerated, and they had to turn around and raise rates again.
It's important to note that the Fed was perhaps more influenced by political groups in the late 1970s and early 1980s than it is now. The president at the time was putting quite a bit of pressure on the Fed to cut rates and not be as aggressive. Meanwhile, the Fed also didn't have as good a read on things like inflation expectations as they do today, and they also did not have an explicit 2% inflation target like they have today. If back then they had been able to see that inflation expectations were not coming down and were rising, they may have acted differently.
How are rising gas prices impacting inflation and consumer spending?
Henderson: CPI is a basket of goods and services that consumers usually buy. Energy, including gasoline, is about 10% of that basket of goods. If you look at the last 12 months, gasoline prices have come down, which has contributed to the downward trend in inflation.
However, in the last two to three months gasoline prices have come up, which also helped drive up CPI in August. I don't think the energy market is in balance: oil demand is exceeding production, and that likely will be the case the next couple of months as the Saudi Arabian Oil Group has extended its production cuts.
Lower-income consumers will be negatively impacted by these higher gas prices the most because they'll have to spend more of their incomes on necessities like gas. Plus, among all consumers, gas is a basic necessity that people buy frequently. Each time people go to the gas station and see prices close to $4, it has a dampening effect on consumer confidence levels.
What are some other problem areas in regards to inflation?
Henderson: The other potential problem area is rents, which have come down but not at a level that supports 2% inflation. One reason for this is high home prices, which indirectly affect rent because, if mortgage interest rates and home prices are high, people are less likely to buy homes and lean towards renting. Strong job growth has also been pushing rents up because it is positively correlated with demand for housing.
The bottom line: If the Fed holds rates up at these high levels, we may eventually get to a balance between the supply and demand for goods and services, Henderson said. They might need to nudge rates a little higher, but we're probably close to the end of the rate-hiking cycle, he said.