The Fed hikes rates. What happens now?

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Sam Azzarello: Welcome to J.P. Morgan's Making Sense. My name is Sam Azzarello and I lead content strategy within global research for JP Morgan. Today, I'm joined by our chief U.S. economist, Michael Feroli, to get his take on September's FOMC meeting and decision. Thanks for joining us, Mike.

Mike Feroli: Thanks, Sam.

Sam Azzarello: So just in time for American football season, the Fed has called for a hike, 25 basis points to be exact. What do you think of the decision? And I guess how would you read it in light of FOMC Chair Warsh’s recent messaging that the central bank has "work to do"?

Mike Feroli: Yeah, so in big picture, the decision came in pretty much as we and many others expected. It was unanimous and the dots point to one more hike likely this year. So how does this fit in with particularly his Jackson Hole speech? Well, I think a lot of people read that as hawkish, as some would say even painting himself into a corner in terms of if inflation between Jackson Hole and this meeting came in firm, then they would need to hike. So I think his speech at Jackson Hole, along I should say with several other Fed speakers, really teed this up. And given the inflation developments between then and now, that's exactly what happened.

Sam Azzarello: So there's a cornucopia of inflation data. Core PCE, the trend, it's been above 3% every month this year, but the three-month annualized pace has improved. We also had August CPI and PPI data. How do you think the Fed weighs these different inflation signals leading to this meeting and then going forward?

Mike Feroli: Yeah, so at the end of the day, the core PCE measure is the one they really focus on. CPI and PPI inform estimates of that. There's some debate as to whether you want to look at three-month annualized trends, year ago trends. I think each participant on the FOMC has a different view of that. Before the meeting, Governor Waller highlighted the improvement in the three-month trend. However, it seems like the sustained above 3% on the year ago measure is probably what mattered more. So the trend is what matters as Chair Warsh said, but the marginal information on the trend is each data point. And I think particularly as we look ahead to the next meeting in late October, we're going to have to think about how much weight to put on the one data point we really get between now and the next meeting.

Sam Azzarello: So let's zoom out for a second and talk about the neutral rate. Does this hike imply anything to you about where the Fed sees the neutral rate and how restrictive policy might still be today?

Mike Feroli: Yeah, that was one of the more confused aspects of the communication coming out of yesterday. So in the dot plot, the longer run dot is commonly interpreted as the neutral rate. That longer run dot, the median longer run dot moved up a little bit to three and a quarter percent. The funds rate right now is just below 4%. And Chair Warsh mentioned that he didn't see it as restrictive. In other words, he didn't see policy rates as above neutral. He also said the hike was to remove a dose of accommodation, neither of which are consistent with how you should normally read the dot plot, which is a funds rate above the median dot should imply policy is restrictive. So there is some mixed messaging we're getting out of the committee and its chair in terms of neutral. But I would say for probably most committee participants, they would likely say, and we'll hear in coming weeks when they come out of the blackout, that policy is modestly restrictive.

Sam Azzarello: So Mike, you mentioned one more hike potentially this year. How much room, if any, do you think the committee has to pause after this move if the next data prints are different than what might be expected?

Mike Feroli: Yeah, so the next meeting is in late October. You really only get one set of data reports between now and then. So one employment report, one inflation report and so on. So that doesn't give you a whole lot of new information. So I think the committee, if they communicate it well, could make a case that they want to wait and see the effect of this hike before moving. And certainly in the past there is precedent for them to move at a quarterly tempo. So we saw that, for example, in the rate hike cycle in 2017 and 18. So I do think they have some room here to take a pause before hiking again, but I do think that needs to be communicated well in terms of given a reason why they would take a pause and not hike. Of course, the easy way to take a pause is if the next set of data are all on the weak side.

Sam Azzarello: Okay. So you already mentioned some of Warsh’s comments during the press conference and the conference felt relatively short compared to those we've seen in the past. Were there any other comments during the press conference that caught your attention?

Mike Feroli: Not so much, but you did mention the format. So this time there were no follow-up questions allowed. They deprioritized some of the more high profile Fed reporters and it was shortened to a half hour, and that's a gradual ratcheting down from what used to be an hour long press conference. And then in that half hour, I didn't learn too much because I think while there were some good questions, Warsh mostly avoided giving direct answers to those. So we didn't learn a ton, I don't think, in the press conference.

Sam Azzarello: Do you think there's anything to make of the fact that the committee vote was unanimous?

Mike Feroli: Yes. I think it shows that while you had a few people who before the meeting were not itching for a rate hike, the fact that they won along, I think sends a message which is helpful I think for the Fed that they do have some resolve here when it comes to inflation, and that probably also helps Warsh in terms of his ability to maintain credibility.

Sam Azzarello: Then that's a good segue to talk about Fed independence. So the administration and other market participants have maybe called for lower rates, easing of rates, yet the Fed went forward and raised rates. Do you think this puts any concerns around Fed independence at ease?

Mike Feroli: Yeah, I think it's a good step towards showing independence. We can never be 100% confident that independence is going to be maintained depending on what happens with the courts, et cetera. But I do think this was definitely a good first step in terms of showing that the Fed can act at odds with the president's will, which is the whole point of independence.

Sam Azzarello: Okay. Mike, to round us out, let's get your view on what matters most from here. Core PCE, labor market strength, energy prices, overheating demand. I mean, the list goes on. What do you think market participants and the Fed are really focused on from here to the end of the year?

Mike Feroli: Yeah. Well, first I would say just looking back over the past three or six months, what really mattered for the Fed were those core PCE inflation readings. And while that will continue to be the case, I do think the labor market could get interesting here. We've recently started to see some hints that perhaps the labor market may be tightening up. Again, there are hints, which is why we want to keep watching it. But if the labor market were to tighten, then I think we may be in for more than just one rate hike, if that were indeed to be the case. So again, we're going to keep an eye on core PCE, but I think some developments in labor market are going to bear more watching than they did over the past six months.

Sam Azzarello: Thanks for joining us, Mike.

Mike Feroli: Thanks for having me, Sam. Take care.

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