Stubborn inflation sets stage for Federal Reserve to hike interest rates

• The Fed has held rates steady at 3.5%-3.75% for all five meetings in the current year, but stubborn inflation metrics are forcing action
• Markets anticipate multiple rate hikes through year-end, with a 49.7% probability of two additional 25 basis point increases and 28.9% chance of three hikes
• Vanguard economist warns that failing to raise rates could push Treasury yields even higher and create an 'adverse reaction' unless the Fed provides strong justification

Summary: Federal Reserve Expected to Hike Rates Amid Persistent Inflation

Key Development:

The Federal Reserve is widely anticipated to raise interest rates at its upcoming September meeting, with market expectations showing a 92.5% probability of a 25-basis-point hike versus just 7.5% odds of rates remaining unchanged.

Current Situation:

• The federal funds rate currently sits at 3.5%-3.75%, unchanged through five FOMC meetings this year
• Inflation remains stubbornly above the Fed's 2% target:
• PCE index: 3.7% annually (July)
• Core PCE: 3.3% annually (July)
• CPI: 3.4% annually (August)
• Core CPI: 2.4% annually (August)

Market Implications:

The 10-year Treasury yield is hovering around 5%, the highest level since 2007, increasing federal debt servicing costs and contributing to budget deficit concerns. According to Vanguard senior economist Josh Hirt, failing to raise rates could trigger an adverse market reaction and push Treasury yields even higher.

Outlook:

Market probabilities suggest aggressive tightening ahead:

• 49.7% chance of two additional 25-bp hikes by year-end (reaching 4%-4.25%)
• 28.9% probability of three hikes (reaching 4.25%-4.5%)
• Only 20% chance of just one hike through December

Hirt suggests a rate hike this week could actually relieve market pressure, potentially causing yields to retract from current levels. The accompanying "dot plot" forecast will provide crucial guidance on policymakers' future rate path expectations. Fed Chair Kevin Warsh has notably declined to submit his own projection, opposing forward guidance practices.