Global central banks face a pivotal week as sticky core inflation and triple digit crude oil heat pressure from policymakers to raise interest rates now. U.S. stocks rebounded and bond markets stabilized at the end of last week, as a warmer than expected inflation report brought needed, needed clarity to Wall Street ahead of the Federal Reserve decision.
So joining me to talk about this and more is Brian Jacobsen, chief economist at Annex Wealth Management. Brian, welcome to the show.
Thanks for having me.
So Brian, US core CPI top forecast as oil diesel tracked higher. Now Chair Warsh is facing public pressure from the white House to cut rates just as core inflation accelerates. So can a single 25 basis point move actually anchor inflation expectations.
You know this is where it gets more into the psychology than the mechanics of a rate hike. I think that my personal preference would be for them to just keep rates on hold, see how things shake out, because if they hike rates, it's not like it's going to build diesel refineries. It's not going to get oil flowing through the Strait of Hormuz.
It's not going to do anything about tariffs. Right. But I think that there is that symbolism part here. And symbolism might be more important than substance to the fed at this point. Just given a lot of that political pressure that is being applied to the fed. President Trump regularly calling for rate cuts.
But Chair Warsh maybe meeting feeling like he wants to assert his independence. And plus we can look at the data and make a kind of weak argument, I think for a hike where we see core services. So that's excluding food and energy where that is beginning to trend higher again. So a big fear has been. At what point do high energy prices begin to seep into like core services and core goods.
So I think that there's a weak case to be made for the A rate hike on Wednesday based on the substance. But I think really what's going to drive it is the symbolism.
Yeah. And it's definitely a question that a lot of people have on their mind. So so Brian, let's talk about Chair Walsh again. And he he has rejected traditional forward guidance, criticizing it as a monetary hall of mirrors. So without clear rate signals from the fed, how are the markets supposed to determine where the terminal rate settles this cycle?
Yeah, that is the big unknown is if he's not going to give four guidance or even what we call a reaction function, right. So a forward guidance is saying what you expect that they will do in the future, whereas a reaction function is more about how will the fed react to the incoming data. And he hasn't made either.
We've he's rejected forward guidance, which I can kind of understand that it's not necessary to do all the time. It's probably more in case of emergency where they want to say, hey, we are committed to keeping rates lower to keep the economy running hot during a period of Crisis, right? That's typically where forward guidance should be used.
But what we really want is a reaction function. Like what are the data points he's really focusing on. And then how might he respond to it? I think he gave a little bit of a peek behind the curtain when he spoke at Jackson Hole, suggesting that he can be singularly focused on inflation because it's not making a rapid enough progress towards their target.
So I think it really suggests that as long as we look at, let's say, a three month moving average of inflation, if that looks to be in an uptrend, then that means they should hike. If it's in a downtrend, that means that they can kind of relax or stay on pause. Unfortunately, since June we have seen inflation, the month on month inflation trending higher.
And I think that's the argument that can be made that his reaction function responding to the data would suggest that he should hike rates here.
No, it's definitely going to be interesting because I know that a lot of people are going to be eyeing his every word on Wednesday. So I want to ask this Brian. So when the fed releases its updated dot plot, do you expect policymakers to signal a one and done recalibration or a broader hiking cycle through the end of the year?
Yeah, that is a great question, and I think that it's probably going to indicate not a one and done, but maybe the beginning of a very shallow rate hiking cycle here, not necessarily something all that steep where they're going to aggressively hike rates like they had to do in the wake of the large inflation that we had coming out of Covid, but probably something where it's going to be a more measured tamping down of inflation and inflation expectations, probably signaling that a majority of the members of the committee are going to support not just one hike this year in September when we get it, but probably another one in December, possibly one more.
So I wouldn't say it's a one and done. It might be more like a three peat that we end up seeing, and then they would think that perhaps they've put sufficient pressure on inflation and inflation expectations such that then they can think about probably first quarter of 2027 to start removing some of that restriction.
Yeah, Brian, and I think that's something that everyone is asking how many rates rate hikes may happen. So let me ask you this. Heading into Q4, there were many risks to consider as we head into Q4, hiking interest rates to counter supply side energy shocks. Monetary policy that can't control is a classic policy dilemma.
So is the fed running the risk of pushing the U.S. economy into stagflation and to being stagnant, or has the neutral interest shifted to structurally higher?
Yeah, I think that really right now, the way that I'm looking at it is that as we go into Q4, they aren't really at risk of they want to avoid stagflation at all costs, right? The combination of a stagnating economy and high inflation. And then if they had to choose between contributing to a stagnation or inflation, they would really rather contribute to the stagnation just given where the unemployment rate is now.
Unfortunately, the parts of the economy that most are most interest rate sensitive are like durable goods housing. It's the areas where, you know, a lot of individuals are seeing the growth there. It's beginning to improve. Do you really want to take that away? The service side of the economy isn't nearly as interest rate sensitive, so that's where it's more symbolic to deal with the inflation expectations as opposed to the reality of inflation.
But they're of the opinion, just like many other central banks, that the economy is resilient enough to withstand a rate hike. And that's actually kind of dangerous because that means they could push it too far. Right. At some point it's no longer resilient. It becomes much more vulnerable. Thankfully, I think that the economy could withstand it.
Not that I'd like to see it, but I think that if we do get that rate hike, we're probably going to see a slight slowing. But in targeted sectors of the economy like autos, housing and then also the redistribution effects. It increases the cost of borrowing, especially for lower income individuals. So it's not a great setup, but it's not one that the US economy won't be able to withstand.
Yeah. No Brian, that's definitely interesting. And again, people are obviously eyeing this. So to wrap up, we know that Treasury secretary is active in the bond market with expanded buybacks to lower long term borrowing costs. While Chair Walsh is leaning towards a rate hike to tighten financial conditions.
So our fiscal debt management and monetary policy now working at direct cross purposes.
They really are. And I think that's the real challenge here. And perhaps behind closed doors, they argue about quite a bit because with Treasury Secretary Scott percent increasing the repurchase of some of those longer dated securities, what it does is it basically makes the interest payment on the debt more sensitive to short term interest rates, less sensitive to what's already been embedded in the whole structure of the debt.
And so, in a way, uh, what Treasury Secretary Vicente is doing by trying to keep those longer term rates a little bit lower. It's increasing the sensitivity of interest on the debt to what the fed does. And I'm sure that is a real contentious issue. Just for perspective, we spend more on interest on the debt than we do on defense spending.
And so if all of a sudden the Treasury secretary is buying back longer dated bonds and replacing them with shorter dated ones, that means that that's actually the interest payment on the debt situation is going to get worse instead of better.
Yeah. Well, Brian, thank you so much for your time today and your input again. Brian Jacobsen, chief economist for Annex Wealth Management.
Thank you.
