Inflation Heats Up as Fed Decision Looms
Higher energy prices provided the fuel for a hotter-than-expected report on US consumer inflation.
The Federal Reserve followed through on an expected September pause on Wednesday but signaled that interest rates will stay higher for longer, maintaining a hawkish posture against inflation amid durable consumer spending and stronger-than-expected economic growth. In an updated set of economic projections, the Fed continued to suggest that it will raise rates by another 25 basis points by year’s end, while it penciled in fewer rate cuts over the next two years compared with forecasts published in June. The Fed’s outlook shows that policymakers expect to keep policy tight for an extended period after seeing how the economy has tolerated higher levels of interest rates and inflation. This further illustrates that investors are facing a far different environment than the so-called Great Moderation that defined the recovery from the 2008 financial crisis.
The Fed and other central banks are weighing exactly how high rates need to rise, and for how long, to quell inflation without triggering a sharp economic downturn. UK inflation bucked forecasts by cooling in August, prompting the Bank of England to forgo a rate hike on Thursday. In the US, the run-up in Treasury yields of late—and the corresponding increase in real rates—may have the effect of constricting growth through tighter borrowing conditions. A slowdown in hiring, a strike by auto workers, the resumption of student loan payments, and a potential government shutdown also contribute to uncertainty surrounding the outlook, giving the Fed room to take a more methodical approach to setting rates. Meanwhile, a recent surge in oil prices threatens to curb growth while driving up prices for other goods and services, a reminder that new inflation risks may still emerge. In a new post on The Bond Blog, PGIM Fixed Income explains that while higher rates are still possible, yield levels are back to historically attractive levels that point to productive conditions ahead.