Fed Holds Rates Steady, Signals Increased Likelihood of Hikes This Year

The U.S. Federal Reserve has decided to keep its benchmark interest rate steady, but the call for rate hikes from three members of the Federal Open Market Committee (FOMC) has increased the likelihood of additional increases this year.

Last month, all 12 voting members of the FOMC agreed to maintain the current rate, but this time, three members advocated for a 0.25 percentage point increase. In the Fed's recent interest rate projections, half of the members anticipated at least one rate hike by the end of the year. Analysts suggest that the possibility of rate increases has grown due to rising inflation.

On July 29, following a two-day FOMC meeting, the Fed announced it would keep the benchmark interest rate at 3.50% to 3.75%. This marks the fifth consecutive month of holding rates steady, with the decision passing by a vote of 9 to 3.

Three dissenting members—Cleveland Fed President Loretta Mester, Minneapolis Fed President Neel Kashkari, and Dallas Fed President Lorie Logan—argued against the hold and called for a 0.25 percentage point increase. This is the first time since September 2016 that three members have voted against the FOMC's decision to hold rates.

A notable change in this meeting is the emergence of voices within the Fed advocating for rate increases, as reflected in the voting.

Mester, Kashkari, and Logan had previously voted against policy decisions in April, but at that time, they opposed the language that left open the possibility of rate cuts rather than the hold itself.

This time, all three explicitly called for a 0.25 percentage point increase. The internal dialogue within the Fed has shifted from a cautious stance on rate cuts to a stronger call for increases.

The possibility of rate hikes this year was also confirmed in the Fed's recent projections. The dot plot from June indicated that among the 18 members who submitted forecasts, nine expected at least one rate hike this year. Eight members anticipated that the current rate would remain unchanged through the end of the year, while only one member projected a rate cut.

Of the nine members expecting a hike, six believe that two or more increases are necessary this year.

The median forecast for the Fed's year-end interest rate has risen from 3.4% in March to 3.8% in June. During the same period, the projected inflation rate for personal consumption expenditures (PCE) increased from 2.7% to 3.6%, while the core PCE inflation rate, excluding food and energy, rose from 2.7% to 3.3%.

Fed Chair Kevin Wash has also not ruled out the possibility of future rate increases.

In a press conference, Wash did not specify how rates would be adjusted but stated he would not hesitate to make changes if necessary. He emphasized that it is difficult to conclude that the high inflation, which has persisted for over five years, has been resolved by only a temporary slowdown in prices. He reiterated the Fed's commitment to achieving its inflation target of 2%, suggesting that if inflation remains elevated, rate hikes could be a necessary response.

The primary reason the Fed is keeping the door open for rate hikes is that inflation continues to exceed its target significantly.

The PCE price index, which the Fed closely monitors, rose 4.1% in May compared to the same month last year. The core PCE price index, excluding food and energy, also increased by 3.4%, surpassing the Fed's 2% target.

The U.S. economy and job market have not deteriorated to the extent that would necessitate a rapid reduction in rates. In its statement, the Fed noted that the U.S. economy is expanding at a solid pace and that the job market remains relatively stable.

However, this meeting did not send a clear signal that an increase is imminent.

The recent slowdown in inflation is a factor that could reduce the necessity for rate hikes. The consumer price index (CPI) for June rose 3.5% year-over-year, a significant decrease from May's 4.2%. The core CPI, excluding food and energy, also slowed from 2.9% to 2.6%.

If this trend of declining inflation continues, the Fed may find less need to raise rates further.

Financial markets did not interpret this meeting as an immediate signal for rate hikes. Prior to the meeting, markets had priced in nearly a 100% chance of a September increase if rates were held steady this time. However, following the policy announcement, the CME FedWatch tool indicated the probability of a September rate hike dropped to about 57%.

The next FOMC meeting is scheduled for September 15-16. Economic indicators related to inflation and employment released before that meeting are expected to be key factors in determining whether rate hikes will occur this year.

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