Fed Rate Hikes: Waller, Musalem Back More Tightening

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Fed rate hikes are back on the table as Waller and Musalem call for more tightening, with traders pricing about an 83% chance of a December increase.

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Two Federal Reserve policymakers said on October 8 that the central bank must raise the fed rate further to bring inflation back to its 2% target. Governor Christopher Waller and St. Louis Fed President Alberto Musalem delivered the message within hours of each other. Futures markets now price roughly an 83% probability of a rate increase at the December meeting.

What Did Waller and Musalem Say?

Waller said additional hikes will be needed to bring inflation down faster if economic data evolve as he expects. In a speech on Thursday, he said there is flexibility on timing. The increases do not have to come at consecutive meetings, but they should be in place within an acceptable period.

Musalem said interest rates may need to rise further over the next six to nine months to return inflation to 2%. Asked about the October 27-28 meeting, he said he is open to a move but has not reached a view on whether to act then.

The two officials differ on emphasis. Waller stressed the direction of travel and the room to space out moves. Musalem set a longer horizon and kept the October decision open.

Why Are Traders Pricing a December Hike?

Traders price a December hike because the comments from both officials point to tightening that does not need to start at the next meeting. Waller's remark that hikes need not be consecutive makes October less certain and December more likely as the first step.

Federal funds futures, which track bets on the policy rate, had implied about an 85% chance of at least one increase by the end of the December meeting as of October 7. Pricing has since settled near 83% for a December move, with a smaller probability of two increases. The Fed's next hike is now expected in December rather than at the October gathering.

How Does This Affect the Fed's Policy Path?

The remarks shift the debate within the federal reserve from when cuts might resume to how much more tightening is required. Both officials framed the case around inflation that remains above the 2% goal, not around a new shock to growth.

A phased approach would give policymakers time to assess how earlier increases are feeding through to prices, hiring and borrowing costs. It would also leave room to adjust if incoming data soften. Waller's conditional language, tied to data coming in as he expects, signals that the path is not fixed.

For markets, higher expected policy rates tend to lift Treasury yields and the dollar and pressure rate-sensitive assets. Borrowers face a longer stretch of elevated costs on variable-rate debt, while savers see deposit rates stay high.

What Comes Next for Interest Rates?

The next test is the October 27-28 meeting. Musalem's openness to a move keeps a nonzero chance of action there, though pricing favors a hold followed by a December increase.

Data on consumer prices and the labor market before December will determine whether the market's conviction holds. Softer readings would weaken the case for back-to-back moves, while firm inflation would support the six-to-nine-month tightening window Musalem outlined.

Outlook

Waller and Musalem have aligned behind further tightening to return inflation to 2%, with the timing left flexible. Futures pricing of about 83% for a December hike reflects that view. The October 27-28 meeting and the data ahead of December will set the pace of the next increase.