Fed Governor Barr Signals October Rate Hike as Inflation Pressures Intensify

An October interest rate hike moved to the forefront of market expectations this week after Federal Reserve Governor Michael Barr expressed support for further monetary policy tightening, coinciding with fresh economic data showing inflation at its highest level in nearly four years. Markets now price in better than 70 percent odds that the Federal Open Market Committee will approve another quarter-point increase when it meets October 27-28.

Speaking at a housing conference in Chicago on September 23, Barr made clear that policymakers have more work ahead even after approving a 25-basis-point rate increase just last week. "In my base case, further policy adjustments are likely to be needed to ensure inflation comes down to target in a timely fashion," Barr stated. "We want to support sustainable, durable growth in support of maximum employment, and price stability is crucial to that."

S&P Data Shows Surging Price Pressures

Barr's comments arrived the same day S&P Global released its flash purchasing manager surveys, revealing that both manufacturing and services industries hit their highest activity levels in more than four years. The services index jumped to 58.7, its peak in 59 months, while manufacturing climbed to 56.7, the highest reading in 53 months. The composite measure rose to 58.4, a 62-month high. Any reading above 50 indicates expansion.

More troubling for the Fed's inflation fight, S&P's overall price measure reached its highest level since October 2022. The firm attributed the surge to higher fuel and transportation costs combined with rising wages. "Firms' input costs have meanwhile jumped in September at the steepest rate for four years, with fuel and transport costs spiking higher thanks to the rise in oil prices seen during the month, which will add further to the upward pressure on selling prices and inflation in the coming months," explained Chris Williamson, chief business economist at S&P Market Intelligence.

Employment Picture Complicates Fed's Path

Adding another layer to the Fed's decision-making, companies reported needing more workers to handle order backlogs. Job growth in the PMI surveys rose "at a rate not seen since June 2022 and a pace rarely exceeded since comparable data were first available in 2009," according to S&P's survey narrative. Service sector employment hit its fastest expansion rate since June 2002, while manufacturing employment reached its highest pace since February 2021.

This strong labor market data reinforces the case for continued rate hikes, as the Fed faces the dual mandate of keeping employment strong while bringing inflation back to its 2 percent target. Treasury markets reacted swiftly to the news and Barr's remarks, with the 2-year note yield, considered most sensitive to Fed policy expectations, climbing more than 13 basis points to 4.9 percent.

Path Forward Remains Uncertain

The probability of an October rate hike jumped to 73 percent according to CME's FedWatch tool, which calculates odds based on 30-day Fed funds futures contracts. Last week's increase took the benchmark rate to a target range of 3.75 to 4 percent. Barr called that move an "important action" and noted the committee was "out of position" on rates, requiring "an adjustment in the right direction."

Earlier this week, regional Fed presidents Alberto Musalem of St. Louis and Susan Collins of Boston, neither of whom are FOMC voters this year, both indicated they see a need for further rate increases. Of the 18 FOMC meeting participants who submitted projections last week, only two did not expect another increase this year. While some had speculated the committee might wait until after November's midterm elections to hike in December, Barr's comments and the economic data suggest policymakers are prepared to act in October if conditions warrant.