- Sticky core inflation keeps pressure on the Fed to hike the FFR rate.
- Mixed macro data gives support to both hawks and advocates of patience.
- Consumption and investment softness weaken the case for immediate tightening.
- Labour market resilience is fading, with job creation lagging prior cycles.
- Despite higher hike odds, our call remains a near-term Fed hold.
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COMMENTARY: Fed’s options
Should the US Federal Open Market Committee (FOMC), begin raising the Fed Funds rate? Are US economic conditions characterised by risks that need to be mitigated by higher borrowing costs? These questions will be confronting the FOMC members as they meet later this week (July 28-29). The year has turned out to be quite different from where things were at its beginning, when expectations were very much tilted toward monetary accommodation. But sticky core inflation, fuelled by electronics, immigration, tariff, and services prices, has become concerning, compounded by the Iran war-induced headline fuel inflation.
For a central bank ostensibly targeting 2% inflation, 3%+ core inflation since December-2025 is problematic to say the least. Some FOMC members ought to be scarred by the memories of the mid-2021 to mid-2022 period, when policy was kept extra-accommodating despite soaring core inflation. That episode alone should inform proactive decision-making this round.
The macro dataflow at the current juncture is however mixed, offering some ammunition to those in favour of a wait-and-see approach. While the AI-adjacent part of the economy is hot, the rest of the economy is somewhat lacklustre. Consumption has cooled a tad, perhaps owing to fuel price surge, dragging down Atlanta Fed’s 2Q GDP Nowcast to below 2%. Inflation may be more supply side than demand side.
Then there is the relationship between money supply growth and inflation, something that is being argued forcefully by former FOMC member Stephen Miran. M2 growth was substantial before the 2021-22 inflation spike, but it is not presently. Someone critical of the Fed then would not use this data to be critical now. FOMC chair Warsh could well be in such a camp.
The production side of the economy is strong, but the investment side, despite the AI spending surge, is soft. Total real investment rose by just 0.4% in 2025, and was down 3.3%yoy in 1Q26. Public spending contribution to growth has also been negative lately.
Does the labour market warrant caution? Not quite. While the unemployment rate is low and real wage growth is still positive (but barely), job creation is lagging the Trump 1.0 and Biden years substantially. Add to that the angst around AI, labour market sentiments are hardly constructive overall.
Should the Fed go ahead with a couple of precautionary rate hikes just in case, given the buoyancy in asset markets and the need to maintain credibility? We think some, but not enough, FOMC members think along those lines. Our view is that once wage growth (around zero in real terms), retail sales (on the soft side), and the public debt situation (enormous forthcoming issuances tilted toward short duration) are considered, the case for pause, for the time being, remains. We don’t reject the market pricing that the odds of a hike have risen, we just don’t think they have risen enough. Our call remains on the side of a hold.
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