The Federal Reserve raised interest rates on Wednesday. The quarter-point hike lifts the overnight lending rate to a range of 3.75 percent to four percent. It is the first increase in more than three years. Chairman Kevin Warsh said inflation is too high and has been for too long, defying President Donald Trump’s repeated demands for lower rates just weeks before midterm elections. The unanimous vote by the open market committee came as fuel prices soar amid the US-Iran war and consumer prices climbed 0.4 percent in August, the highest increase in four months.
Warsh was blunt. “The plain fact is that inflation is too high and has been for too long,” he said. This summer’s readings do not show that underlying trends have meaningfully improved, he added. The Fed’s statement described economic activity as expanding at a solid pace with resilient domestic spending, even as uncertainty remains elevated owing in part to geopolitical developments. Warsh acknowledged shifting geopolitics without naming the US-Israel war with Iran directly. “There’s no hiding from hot spots around the world, and our judgment about what is the most likely or least likely of the geopolitical situation has changed,” he said.
Warsh declined to predict Trump’s reaction. He said Fed independence is a two-way street. “We will let people that do trade policy and fiscal policy stay in their lane,” he said. “That is the way we can stand up here and call them the way we see them.” Trump nominated Warsh expecting rate cuts. Instead, the president has said the US should have the “LOWEST RATE of any country in the World” and threatened to stop trading with countries that run deficits against the US if the central bank does not comply.
Political collision and market fallout
The hike sets Warsh on a collision course with the White House. According to Al Jazeera, Trump repeatedly berated Warsh’s predecessor, Jerome Powell, for not lowering rates, and the government launched a criminal probe into Powell, which he called “pretexts” to undermine the Fed’s independence. The White House did not respond to requests for comment. Stocks tumbled after the announcement. The Dow Jones Industrial Average fell 700 points in late afternoon trading, with losses accelerating during and after Warsh’s press conference. Jeff Gundlach, founder of DoubleLine and one of the most prominent bond investors, said he was not surprised. “I thought the content was pretty thin,” Gundlach said of Warsh’s remarks, calling the chairman “opaque.”
Gundlach argued the Fed should have hiked by more. “I would have just done the 50 and then see what the data does,” he said on CNBC’s “Closing Bell,” advocating for a half-point increase that would have provided what he called a “truing up” to the Fed funds rate. The 2-year Treasury rate sat more than 100 basis points above the Fed funds rate, according to Gundlach, who said the 2-year Treasury “leads” the Fed. He worries the inflation problem is not “fully respected.”
Bond market stress and inflation’s grip
The 10-year Treasury yield climbed back above five percent. It rose two basis points to 5.016 percent after the decision. The yield had broken above the psychologically important five percent threshold on Tuesday, hitting 5.02 percent, its highest level in 19 years. The 2-year Treasury note yield rose more than seven basis points to 4.738 percent, erasing an earlier decline. The 10-year yield serves as a benchmark for borrowing costs including car loans and home mortgages, and trouble in the bond market can lead to higher interest rates for consumer and business loans.
Energy prices are a major driver. Brent crude hovered near $109 per barrel on Tuesday as strikes in the US-Israel war on Iran intensified. The average price for a gallon of petrol reached $4.36, up 14 cents in the past week and up from $4.06 last month, according to the American Automobile Association. Diesel hit $6.31 per gallon. That is the highest recorded average, roughly double from a year ago. Diesel fuels trucks that haul everything from fruits and vegetables to steel and cement, which is expected to further stoke prices.
Fed officials expect one more rate increase this year, according to their quarterly projections, with four officials predicting the benchmark rate will reach 4.25 percent to 4.5 percent by year’s end. Officials believe it will take roughly until 2029 for inflation to reach its two percent goal. Kay Haigh, global head of fixed income at Goldman Sachs Asset Management, said the Fed likely will skip October’s meeting given its proximity to the midterm elections, with one more hike in December as the base case. At its last meeting in late July, the committee voted nine to three to maintain rates, the largest dissent on a policy decision in 10 years.
The economic picture for voters is grim. The Guardian reported that inflation has wiped out wage gains, with hourly earnings for employees decreasing 0.1 percent year-over-year after accounting for inflation and falling 0.3 percent from the prior month. Consumer sentiment has rapidly declined, according to a monthly survey from the University of Michigan cited by The Guardian, while expectations for more inflation have increased. According to The Guardian, Trump has promised every American a $5,000 “Trump dividend” if Republicans retain control of Congress, a move critics have called akin to bribery. The Guardian also reported that US government debt reached a record-high $40tn last month.