To Hike or Not to Hike

Our Global Head of Macro Strategy Matthew Hornbach and Chief U.S. Economist Michael Gapen look at what could speed up tightening, what’s next for Treasury yields, and how the Fed can skip a hike now while signaling that more are coming. Read more insights from Morgan Stanley.

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Matthew Hornbach: Welcome to Thoughts on the Market. I'm Matthew Hornbach, Global Head of Macro Strategy at Morgan Stanley. Michael Gapen: And I'm Michael Gapen, Chief U.S. Economist. Matthew Hornbach: Today, the challenge facing the Fed: to not hike rates while still convincing investors that you think rate hikes are coming. It's Tuesday, October 27th at 11am in New York. So Mike, how do you think the Fed and Chairman Warsh in particular is going to deal with this challenge? Michael Gapen: Well, I think the way that he can do it is to say, ‘Obviously we already did hike. So, we've started a process. You know we're serious about bringing inflation down in a timelier fashion. So essentially the question is: Do we want to raise rates at every meeting or do we want to take an action, assess incoming data and take a different action?’ So I do think the message here can be balanced in a way that says, ‘We didn't hike rates today. We didn't feel a tremendous sense of urgency to raise rates today. But we think more work is needed.’ So I'm not sure that there's urgency to raise rates every meeting. But you can still suggest that rates are going to go higher. You can see I'm having trouble articulating the story as well. Warsh may have some of the same difficulty, but I think that's the basic message is – taking an action, assessing its effect, deciding to take another action. Matthew Hornbach: At the Jackson Hole Symposium in August, Chairman Warsh gave a speech, and in the speech, he invoked this imagery of going on a hike around the mountains of Jackson Hole. And he told us that there were, in essence, two types of hikes that one could go on around Jackson Hole. A more leisurely hike and a more aggressive hike around the mountains. Presumably because we don't think the Fed will hike rates at this meeting. Presumably the idea that he has in his head today is to go on a leisurely hike. But if that's the case, how long does a leisurely hike last? How… Michael Gapen: They can both be the same. Matthew Hornbach: … long will the hike be. Michael Gapen: Yes. So I think that I would interpret the leisurely hike also as the difference between, I think, what economists euphemistically call a recalibration of the policy stance – as opposed to a more aggressive tightening cycle. So one's kind of leaning against the wind while the other one is trying to change the course of the economy. So I think you're right. And he called the leisurely hike the Ben Bernanke hike and as opposed to the Don Kohn aggressive hike. That's inside Fed speak if you know your former Fed staff. And I think what the data is telling the Fed, on one hand growth is certainly resilient, and inflation is sticky. But the labor market doesn't look like it's overheating. We're only adding about 50,000 jobs a month. The unemployment rate is low, that's true. But wage growth is actually decelerating. So from my perspective, and I think their perspective, even with the AI investment boom, there's not a lot of evidence the broader economy is overheating. And that's where I think the urgency story fits in. Are they behind? Do they need to get on top of something? I think the answer to that is no. So you end up with this measured recalibration: Hey, we cut 75 basis points last year to support the labor market, should probably reverse those. That's what we should be thinking. We're not thinking we need to go all the way back to 2023 highs, which would be the more aggressive tightening cycle. That's the way I split it out. Matthew Hornbach: So what would have to happen with the weather in Jackson Hole to change the mind of the committee to go on a more aggressive hike? Maybe to get back i