Could the “87% rate hike” be a market misjudgment? Institutions: The Federal Reserve may still hold steady this week

According to Zhihu Finance APP, Michael R. Strain, Director of Economic Policy Studies and Senior Fellow at the American Enterprise Institute, stated that although financial market pricing shows a high probability of a rate hike, the Federal Reserve is unlikely to raise rates at its September meeting.

Strain said that the "center of gravity" of the Federal Open Market Committee (FOMC) still leaned towards maintaining current rates at the July meeting, and he does not believe that the economic data released since then has been strong enough to substantially change this view.

Strain acknowledged that the August Consumer Price Index (CPI) report could prompt some FOMC members to support a rate hike, but he believes the data would need to be significantly more concerning to trigger the start of a new rate hike cycle from the Federal Reserve.

He pointed out that market pricing places the probability of a rate increase at 87%, but the right question is not whether the Fed should raise rates this week, but whether it should begin a new tightening cycle.

He added that a one-off rate hike would pose a separate communication challenge for Chair Walsh, who may be reluctant to explain why the Fed would implement its first isolated rate hike in decades.

Strain stated that, meanwhile, the August inflation data may not be as concerning as market reactions suggest. Based on the CPI report, he expects the August core PCE inflation to accelerate compared to June and July, but to remain around an annualized level of 3.1%, with the six-month change in core PCE at about 3.2% annualized.

If these estimates hold, Strain believes that most FOMC members would still consider the data consistent with ongoing disinflation rather than a substantial reacceleration of inflation. The year-on-year core services CPI for August stood at 3%, unchanged from July, with almost no evidence of a renewed acceleration in underlying services inflation.

Strain also believes that financial conditions have tightened in recent weeks, possibly achieving part of what would otherwise require a higher federal funds rate.

He said that while avoiding a negative market reaction might be one consideration for policymakers, a one-off hike would itself be contrary to market expectations, with the bond market pricing in about a 75% probability of two or more rate hikes by 2026.

Therefore, unless the Federal Reserve intends to signal that policy under Walsh will differ from his recent predecessors, a rate hike could still catch markets by surprise.

Although Strain expects the Fed to keep rates unchanged this week, he personally favors a rate hike. He believes the federal funds rate is too low, says he would have voted for a hike in July, and opposes a rate cut by the Fed in 2025.

However, he does not believe most FOMC members have substantially changed their assessment since July, so he expects the Fed to keep rates unchanged this week, while acknowledging that if the Fed does finally raise rates, he "would not be shocked."