Three numbers capture the Federal Reserve dilemma as December approaches. Third quarter GDP expanded at an annualised 3.4 percent, beating expectations as consumer spending, investment and government expenditure supported activity. Headline PCE inflation reached 3.6 percent annually, with a monthly increase of 0.5 percent, while core inflation stood at 3.1 percent annually and 0.3 percent for the month. Growth says the economy is resilient. Inflation says price pressure has not been beaten. A central bank facing both must choose which risk to weight more heavily.
The October decision reflected that tension. The Federal Reserve left interest rates unchanged at 3.75 percent to 4.00 percent, as widely expected, yet the 10 to 2 vote revealed a more hawkish committee than the headline suggested. Governor Lisa Cook and Cleveland Fed President Beth Hammack both favoured an immediate quarter point increase, arguing that inflation, not growth, should drive the decision. Chair Kevin Warsh acknowledged that improving productivity could allow faster growth without excessive inflation, a point that supports waiting, but does not remove the inflation concern.
Why growth does not settle the argument
Strong growth can coexist with sticky inflation, and in some ways it causes it. When consumers spend, businesses invest and government spends, demand stays high, which supports prices and wages. That is why a 3.4 percent growth print does not argue for a rate cut, even though it might seem like good news. For the Federal Reserve, good growth news is only reassuring if it comes with cooling inflation. When growth is strong and inflation is above target, the case for holding, or for tightening, strengthens, because the economy appears able to absorb higher rates.
The global macro briefing on 2 November presents the three numbers together, with markets assigning roughly a 72 percent probability to a December increase, down from about 80 percent immediately after the October decision. That slight fall shows markets are not certain, even with sticky inflation, because the jobs report on Friday and the inflation report on 10 November could still change the picture. A weaker jobs print would argue for patience despite strong GDP, because GDP looks backward while jobs point forward.
What the next data must show
For a December hold to become likely, inflation must cool or employment must weaken materially. For a December increase to become near certain, inflation must stay high and jobs must stay resilient. If the data split, with jobs soft and inflation firm, the committee will face its hardest choice, and the December projections will matter as much as the rate decision itself. Three numbers started the debate; two more reports will decide it.
