The debate over the best interest rate direction continued to swirl ahead of Wednesday’s rate-setting vote at the Federal Reserve in Washington.
Even though some parts of the U.S. economy are relatively stable, such as the job market, experts say that stability could be undermined by the potential inflationary impacts of a prolonged war in Iran or the Trump administration’s latest tariff push.
Interest rate traders believe the Federal Open Market Committee will keep the federal funds rate, which sets many other borrowing rates across the economy, at its current level of about 3.6%, where it has been since December.
Even if the consensus is in favor of holding rates on hold, there is an outside possibility that the vote could lead the FOMC to recommend a rate hike.
For many consumers and small businesses, current interest rates have already made the cost of borrowing increasingly out of reach. This has reduced sales of items like automobiles and industrial equipment, which are typically financed.
At the same time, the inflation rate has hovered above the Fed’s 2% target for more than five years, a phenomenon that has exacerbated the ongoing affordability crisis. And even though some recent inflation indicators have started to show declines, the pace of increase in energy and wholesale product prices has remained high.
“Each month of above-target inflation has added pressure on U.S. budgets,” Dallas Federal Reserve President Lorie Logan said in a speech earlier this month, calling for a “mild” rate hike.
The Fed has historically raised rates to slow overall economic activity and control inflation. Faced with stubbornly high inflation, many market participants have called for higher rates, which would put downward pressure on the pace of price increases.
Among interest rate traders, there is broad consensus that the Fed will raise rates before the end of the year. According to CME FedWatchFed Funds futures indicate a 90% chance that rates will be at least 0.25% higher by January.
Another question looms over the central bank’s rate-setting meeting this week: what would be the real impact of a rise in interest rates on prices?
There are currently several reasons why inflation may be less sensitive to rising interest rates than in the past.
High energy prices caused by the war with Iran, for example, and the Trump administration’s tariff policies both help keep prices high for consumers. But experts say higher rates would do little to mitigate these types of geopolitical forces.
“Hiking [interest rates] it will not open the Strait of Hormuz and end the war,” said Adam Turnquist, chief technical strategist at asset management group LPL Financial.
Fed policymakers’ views on the future of the U.S. economy will likely be more of a black box this week than they have been in recent years.
Federal Reserve Chairman Kevin Warsh, who succeeded Jerome Powell in May as head of the central bank, has made a point of not tilting the Fed’s thinking on the direction of monetary policy — much to the frustration of some market participants.
“Chairman Warsh’s communication vacuum has encouraged other policymakers to speak out more forcefully,” said Greg Daco, chief economist at EY-Parthenon, Ernst & Young LLP.
Among those who spoke out, the message remained consistent, Daco wrote in a note: inflation remains too high and rates must rise.
“After months of upside surprises in inflation, patience is running out,” Daco wrote. “If inflation does not return towards 2% soon and remains elevated due to persistent supply shocks, stronger AI-related demand, tariffs or the Middle East conflict, the case for further policy tightening will be clear. »
Other experts are more optimistic that inflation has peaked and the Fed can afford to keep rates at current levels.
“Housing inflation continues to slow, and wage growth – the largest cost of production in services – is not inflationary when adjusted for productivity gains,” wrote Angelo Kourkafas, senior investment strategist at Edward Jones, in a recent client note.
“Furthermore, the new tariffs announced are broadly consistent with previous tariff levels that have expired and are not expected to trigger a further increase in commodity prices,” it added.
President Donald Trump’s latest tariffs – an overall rate of between 10% and 12.5% on dozens of America’s trading partners – represent a continuation of his protectionist trade policies.
But they also introduce new uncertainty into many of America’s most vital economic relationships. Several of the targeted trading partners say the U.S. justification for this round of import tariffs — an effort to combat forced labor — amounts to a sham.
Days after they were announced, the latest tariffs were challenged in federal trade court, plunging them into legal limbo just as importers prepare to start paying them.
Some experts believe that the prices are it is unlikely to survive a legal challenge, adding yet another layer of uncertainty to the economic outlook.