U.S. interest-rate markets are repricing the Federal Reserve’s next move. Fed Governor Michael Barr said policymakers may need to keep adjusting rates after last week’s 25-basis-point hike to ensure inflation returns to target in a timely manner. At the same time, S&P Global’s preliminary September survey showed stronger activity across manufacturing and services, alongside rising business input costs. The combination has lifted expectations for another rate increase at the Fed’s October meeting.
CME tool puts October hike odds at 71%
The CME FedWatch tool showed the probability of another rate increase at the Federal Open Market Committee’s October 27-28 meeting rising to 71% as of September 23. The tool calculates the market-implied probability from 30-day federal funds futures contracts.
Last week, the FOMC raised its target range for the federal funds rate by 25 basis points to 3.75%-4%. Barr called the move an “important action.” He supported the decision alongside the other 11 voting FOMC members. Of the 18 participants who submitted economic projections, only two did not expect another rate increase this year.
Markets had previously considered whether the Fed might wait until its December meeting, after the November midterm elections, before taking further action. Barr’s latest comments and the change in economic data have put an October move back at the center of market attention.
Barr says rates may need to move higher
In prepared remarks for a housing conference in Chicago, Barr said: “In my baseline scenario, further policy adjustment may still be needed to ensure that inflation returns to target in a timely manner.” He also said the Fed wants to support sustainable, durable economic growth and maximum employment, with price stability serving as a key condition for achieving those goals.
Barr said the previous level of interest rates had been “in an inappropriate place” and described last week’s adjustment as “a step in the right direction.” His comments suggest that at least some policymakers do not view the recent hike as a one-off policy move.
Earlier this week, St. Louis Fed President Alberto Musalem and Boston Fed President Susan Collins also said rates might need to rise further. Neither is an FOMC voting member this year, but their remarks are still being watched as indications of the Fed’s internal policy debate.
S&P Global reports faster business activity
S&P Global’s preliminary September purchasing managers’ indexes showed the U.S. services index rising to 58.7, its highest reading in the survey’s 59-month history. The manufacturing index climbed to 56.7, its strongest level in 53 months. The composite index reached 58.4, a 62-month high. Readings above 50 generally indicate expansion in the relevant sector.
The pickup in activity came alongside renewed price pressure. S&P Global said its overall inflation gauge rose to its highest level since October 2022, driven mainly by higher fuel and transportation costs as well as rising wages.
Chris Williamson, chief business economist at S&P Market Intelligence, said business input costs were increasing at their fastest pace in four years in September. Higher oil prices have pushed up fuel and transportation costs, which could continue to lift companies’ selling prices and add to inflation pressure in the coming months.
Employment data also pointed to resilient business demand. Surveyed companies said they needed to add staff to handle backlogs of work. Employment growth reached its fastest pace since June 2022, making it one of only a few periods with such a strong reading in comparable data dating back to 2009. Services employment growth was the fastest since June 2002, while manufacturing employment growth reached its highest level since February 2021.
Two-year Treasury yield rises above 4.9%
The shift in rate expectations quickly reached the bond market. The two-year U.S. Treasury yield, which is particularly sensitive to Fed policy, rose by more than 13 basis points at one point to around 4.9%. An intraday quote put the yield at 4.916%, up 0.139 percentage point. One basis point equals 0.01 percentage point, and bond yields typically move inversely to prices.
The central question for markets is whether business activity and employment growth can remain firm as inflation pressure rises, and whether the Fed will respond by tightening policy again in October. Recent data and officials’ comments have raised the odds of another hike, but the decision will depend on incoming inflation, employment and activity figures, as well as the FOMC’s assessment of the policy outlook before the meeting.