The Fed is debating getting rate hikes out of the way sooner

Washington, DC CNN

Federal Reserve officials have already advocated for two consecutive interest rate increases starting this month in order to defeat inflation. But will their influence hold despite a change at the Fed committee which decides on rates?

Probably.

James Bullard of the St. Louis Fed, who is considered to be one of the Fed's hawkish voices, announced on Thursday that he will step down at end August. Adriana Kugler is a dovish economist who will likely be confirmed by the Senate to serve as a central bank governor.

The Fed's September decision is not as clear, and there will be plenty of data released before then.

It is however clear that historically, the Fed Chair has had a significant influence on the Federal Open Market Committee (the Fed's policymaking arm). Fed Chair Powell said that the Fed has much more work to be done, and he hasn't excluded back-to-back interest rate increases. It is a central bank tradition to respect the views of the majority, even if they disagree. The vote was unanimous in June, despite the debate evident from the minutes of the meeting, which were released earlier this month.

At the moment, the hawks seem to outnumber doves.

Why hiking in September is favored?

Fed Governor Christopher Waller - who is a permanent member of the Fed committee which decides on interest rates - reiterated late last week the view that was widely held among Fed officials, that two rate increases are required this year.

Waller told a Money Marketeers of New York University Forum on Thursday that he was more confident than at the June meeting. With another month of data, he could now evaluate the lending conditions. I do not see any reason why we should not make the first of these two hikes at our next meeting.

He also said that the Fed would prefer to have rate hikes done as quickly as possible.

He said that he would need to wait and see what the data showed. If inflation continues to be stagnant and there is no indication of a significant decline in the economy, a second 25 basis-point [quarter point] increase should occur sooner than later. But that decision will come at a future date.

If the inflation slowdown is stalled, and the labor market is strong by historical standards, and the economy's growth only slightly cools down, then it's best to remove the bandage and raise in September.

According to the minutes of the June meeting, the longer inflation stays high, the greater the risk that inflation expectations will become unanchored. If inflation does not drop soon, Americans may begin to accept higher prices as a permanent reality.

Fed's key federal funds rate is expected to be raised by a large majority later this month, after a pause in June following 10 consecutive rate increases. Officials decided to keep rates at the current range of 5 to 5,25% in order to assess the health of the economy, but mainly because they were uncertain about the impact that the spring bank stress would have on credit.

Minutes from the meeting show that officials were not as united, even though they voted unanimously to pause. Most officials have indicated that they are biased towards a hike for July after voting to hawkishly stop last month.

The Fed's decision in September is going to be difficult because it will need to decide if they want to make their second hike or wait until there are more signs that the inflation rate will not reach the central bank target of 2%. Officials have also made it clear that they want to see inflation fall as quickly as possible.

Will Kugler's inclusion in the FOMC convince hawks to hold off on a September hike? Kugler, a labor economist is well-versed in the Fed's mandate on employment. She also acknowledges that inflation is the current focus.

She told the lawmakers during her confirmation hearing last month that she believed both sides of the mission were very important. "Right now, inflation is critical."

A data-dependent Fed

Credit conditions haven't tightened significantly since three regional banks collapsed earlier this year. Last week, some of the country's largest banks announced record-breaking second-quarter earnings. The Fed's Beige Book also showed that credit availability has not been drastically reduced.

This has given Fed officials reassurance to press on, increasing the possibility of a rate increase in September. But, of course, everything depends on the economic indicators that will ultimately be revealed in the next few months.

Officials are focusing on the core rate of inflation, as well as other sub-measures like services inflation excluding housing and energy costs. These sub-measures have not decelerated at the same rate as headline inflation. The Personal Consumption Expenditures Price Index -- the Fed’s preferred inflation gauge -- increased 3.8% from a year ago in May, down from April’s 4.3%. The core measure, however, only dipped to 4.6%, down from 4.7%. It was at its lowest level since October 2021.

Fed officials may want to raise rates again if core inflation only moderates slightly.

Officials need to slow down the tight labor market further. It is also a source of inflationary stress. Job gains between 70,000 and $100,000 per month are required to keep pace with population growth. Gains close to this range would indicate that the labor market is finally slowing down. If officials are to refrain from hiking the price of gasoline, they will need to see a jobs report that is close to this range.

The FOMC will meet again on July 25 and 26. An announcement regarding rate increases is due at 2 pm. ET on Wednesday, and a Press Conference from Powell at 2:30 pm.