Chances are the Fed will press ahead with four rate hikes

Chairman Powell is likely to adopt a less dovish response compared with recent past

The higher US inflation numbers released last week will add weight to the Federal Reserve’s policy deliberations when the Open Market Committee meets on July 31 and August 1.

The price data, along with continued signs of a solid domestic economy, would encourage Fed officials to signal a rate hike at the following FOMC meeting, in September, and leave open the possibility of a fourth increase this year.

Yet central bankers will need to also take into account the risks to business investment from rising trade tensions at a time of more fragile global economic momentum.

The old Fed, led by Chair Janet Yellen, would have erred on the side of caution and postponed the next interest rate hike until December.

The outlook is less clear under the leadership of the new chairman, Jerome Powell. This uncertainty also makes Powell’s congressional testimony even more worthy of attention.

At 2.9 per cent for the 12 months through June, headline inflation is now at its highest since early 2012. The core measure, which excludes more volatile items such as oil, came in at 2.3 per cent, the highest since the start of 2017. And data released earlier showed that the producer price index rose 3.4 per cent year on year, suggesting there is more inflation in the pipeline.

These increases will bolster confidence within the world’s most powerful central bank that its own preferred measure of inflation, the personal consumption expenditure price index, is likely to settle around its 2 per cent target.

Together with the major progress in the labour market that was highlighted again by the jobs report for June, this implies that the Fed is very close to meeting its dual objectives.

The numbers are also consistent with Powell’s assessment that the US economy is in “a good place” and that the recent tax cuts will provide at least three years of growth stimulus.

But Fed officials need to consider the concerns of companies that are said to be thinking about scaling back or postponing business investment plans due to uncertainties about trade policy.

The topic was featured in the minutes of the European Central Bank released on July 12 and in the Fed minutes. These worries are arising as several economies outside the US risk losing some of their growth momentum and China faces higher financial volatility.

Also, notwithstanding valid offsetting technical considerations, the Fed is unable to totally dismiss the notably flat yield curve reflected in a 26 basispoint differential between twoand 10-year Treasuries and a 36 basis-point spread between two-year and 30-year bonds.

Such numbers have historically signalled a high probability of a domestic economic slowdown.

Unlike on previous occasions, Fed officials this year have notably refrained from making comments aimed at repressing financial volatility during the periods of global market instability between meetings. With that, the markets’ confidence in the “central bank put” has decreased.

Where does this leave me in terms of Fed policy expectations before the important semi-annual congressional testimony on monetary policy on July 17 and 18?

At least for now, I’m sticking to a baseline of a total of three hikes for 2018.

I also think that it’s finely balanced whether the next increase will be in September or December, and that the overall balance of risks is now tilting further in favour of four hikes.