PCE, Oil, Jobs Fuel Rate Hike Debate

PCE and core CPI differ in their measured items and weights; PCE carries a heavier weight on healthcare services and includes items such as trader commissions that CPI does not.

Because the slowdown in inflation the Fed expected did not show up, rate-hike talk spread through the market, and the result is read as meeting the rate-hike scenario laid out at Jackson Hole.

As of September 10, the Dubai premium stood at $27 per barrel, and tanker traffic through the Strait of Hormuz fell to about a third of its normal level.

The alternative route via the Saudi East-West pipeline is also struggling to operate, intensifying upward pressure on oil prices.

Oil prices are especially likely to spike if alternative export routes such as the Saudi East-West pipeline are shut and safe passage through maritime shipping lanes becomes hard to secure.

The September Beige Book noted that firms are struggling to pass on costs, and Williams said the second-round effects of higher oil prices have not yet appeared, confirming the Fed's cautious stance on whether oil gains are carrying into the real economy.

By contrast, the University of Michigan's preliminary September reading, released Friday, showed one-year inflation expectations jumping from 4% to 4.6%, and five-to-ten-year expectations rising from 3.3% to 3.4%, a sharply different picture.

The New York Fed survey was conducted in August, while the Michigan survey was conducted in early September after oil prices rose, so it reflects consumers' heightened sensitivity to prices. In the New York Fed survey, some consumers also voiced concern about their household budgets.

The breakeven inflation rate (BEI) is the gap between inflation-linked bond yields and regular Treasury yields; it reflects the inflation compensation the market demands rather than simple inflation expectations.

The 10-year BEI stood at 2.36%, holding steady even during the oil price surge.

Thursday's statement and press conference should clarify the Fed's direction on future rate policy.

Wall Street Journal reporter Timothy Hillhouse assessed this labor market strength as removing an obstacle to rate hikes.

Figures that once would have signaled a jobs shortfall now exceed what is needed to absorb new entrants; Gene Bianco estimates the current employment break-even point at 20,000 to 35,000 jobs per month.

To judge whether wages are pushing prices higher, one should look at unit labor costs, the labor cost per unit of output, rather than hourly wages.

The key question is whether unit labor costs are moving at a pace consistent with the Fed's 2% inflation target; current wage dynamics do not appear to be acting as a driver of price increases.

Governor Hammack said rates are not meaningfully restrictive, and Governor Warsh said broad financial conditions are hard to call restrictive. Economic indicators remain solid, with corporate profits up 20% and corporate bond issuance surging, and the July minutes acknowledged differences in financial conditions between large and small firms.

Taken together, employment is stronger than its baseline suggests, wages are not a factor pushing prices higher, and no Fed official is calling financial conditions strongly restrictive.

On that basis, the case for holding rates steady on grounds of economic slowdown is weak.

This is called the 'crowding-out effect.'

Government annual interest costs run to roughly $1 trillion, and surging AI infrastructure investment is absorbing savings and pushing up the price of capital.

Both the investment effect that lifts the economy from below must be considered together; if the rise in yields stems from investment, the net effect on the economy must be analyzed rather than assuming it only weighs on growth.

A Fed signal of rate hikes raises the expected real short-term rate; combined with a falling premium and a rising rate path, this produces a flattening concentrated in short-term maturities.

The prevailing view is that the Fed is unlikely to accept rising long-term yields as a substitute for a rate hike.