25 or 50 BP Rate Hike?

The stock market may continue to debate whether the Fed will hike rates by 25 or 50 BPs at the December 8-9 FOMC Meeting.  The latest wage/price inflation data have not been good for the Fed.  And, a decision on the size of a rate hike could depend on whether officials have the patience to wait for the special factors behind some of the higher inflation to recede.  Fed speakers this week, including Fed Chair Warsh, should get much attention.  He had said at his post-FOMC news conference that the upcoming slew of data will be an important consideration at the December FOMC Meeting.  The September FOMC Minutes, released this week, may repeat this comment.  So far the "upcoming slew of data" would seem to argue for a 50 BP rate hike, as would the recent run-up in longer-term Treasury yields (which Warsh has said should help inform the Fed about the economy).  However, concern about doing too much damage to the economy could hold back a rate hike to 25 BPs.

Both the October CPI and PPI are troubling from the Fed's perspective.  The 0.3% m/m Core CPI was the third such high print in a row, after averaging 0.2% m/m over the prior seven months.  And, the headline 0.3% Core PPI masked a much higher 0.5% increase in the underlying Core Less Trade Services PPI.  The latter averaged 0.4% m/m in Q326 and 0.5% in H126.  At best, it shows no let-up in inflation.

Some of the high inflation could be traced to special factors, such as the run-up in oil prices, AI-related shortages, and tariffs, but higher labor cost inflation could be a factor as well.  In particular, wages in the retail sector have sped up since August, averaging 0.3% m/m after averaging 0.1% from January through July.  Retailers could be passing through the higher wages to prices.

Tightening aimed at weakening the labor market is how the Fed would address a labor cost problem.  The conundrum is that people would be hurt by job losses rather than by higher prices.  In either case, lower-income people would probably be hurt the most.  The Fed may decide to balance these two negatives by tightening gradually, voting to hike by 25 BPs in December.  The risk is that longer-term Treasury yields will rise in this case, a negative for the economy and stocks.

To be sure, this week's US economic data may offer reasons to tighten gradually.  Consensus expects a flattish October Retail Sales.  Although the  soft print could be just the typical pause after a strong month (+0.8% in September), it also could suggest a slowdown in consumer spending.   And, while consensus sees an uptick in October Housing Starts (1.23 Mn units after 1.22 Mn in September), the downtrend would remain as it would follow three months of decline.   Consensus expects a 0.1% m/m increase in October Industrial Production, after +0.7% in September.  There is downside risk to Manufacturing Output, however, as Total Hours Worked in this sector fell in October.

Besides Warsh, who is not likely to give an explicit hint about a December FOMC rate decision, other Fed speakers this week should be of interest.  In particular, Fed Governor Barr has been a "fence sitter" with regard to monetary policy, so his comments, if hawkish, could suggest a shift in the majority of FOMC members.  And, NY Fed President Williams, who has tilted toward a gradual pace of rate hikes, will be of interest to see if he has become more hawkish.