Fundamentals Don't Justify a Hike
Recent data on inflation and employment do not support an interest rate increase, according to an analysis by Robin Brooks. The proportion of items in the PCE inflation basket with annualized month-over-month inflation above three percent is trending downward, indicating inflation is not a concern. Similarly, prime-age male labor force participation has declined in recent months, while female participation has plateaued, which would not be expected in a red-hot labor market.[S1]
The Real Driver: Long-Term Yields
The primary factor that could compel the Fed to hike is the level of long-term Treasury yields. The budget deficit is so large that keeping yields from spiraling is a unifying concern across the government. A dovish performance by Kevin Warsh after the Fed's July 29 meeting inadvertently sparked a sell-off, forcing the Treasury to announce a buyback on August 19 to regain control. Long-term yields are the biggest wildcard for the September 16 meeting.[S1]
Political Pressure Raises Hike Odds
President's posts urging the Fed to cut rates paradoxically increase the likelihood of a hike, as they strengthen the FOMC's resolve to demonstrate independence and raise questions about Fed credibility, which could trigger another sell-off in long bonds. Analyst Robin Brooks assigns a 40 percent probability to a 25 basis point hike, more dovish than the market's 62 percent. He notes that a single social media post could tip the scales.[S1]
Implications for Gold and Debasement Trade
If the Fed does hike, Brooks argues it would not be negative for the debasement trade and gold. The intention of such a hike would be to cap long-term Treasury yields, which is central to the debasement trade strategy. This perspective suggests that even a rate increase might not deter investors seeking protection against currency debasement.[S1]
