The Market Is Betting the Fed Hikes Again. The Data Makes That a Hard Bet to Dismiss.

According to CNBC, traders have pushed the probability of a Fed rate hike at next week’s meeting to 70%, up sharply in morning trading on September 10th. The surface read is straightforward. The more interesting question is what the backdrop actually justifies.

Start with where rates already sit. The federal funds target range is 3.50%-3.75%, and core inflation is running hotter than roughly nine of every ten months in the historical record. That is the policy problem in a single sentence. When inflation is that elevated relative to history, a central bank that holds rates steady is effectively easing, because the real cost of borrowing stays suppressed. The Fed knows this. So does the bond market.

Long-term interest rates are already sitting in the upper quarter of their historical range, meaning financial conditions are genuinely tight on paper. But tight rates hurt the economy unevenly. Businesses with floating-rate debt feel it immediately. Companies with locked-in fixed rates may not feel it at all for years. Credit spreads, meanwhile, are near their narrowest readings in the historical record, which signals that bond markets are not pricing meaningful default risk right now. That divergence, hot inflation and tight policy alongside very calm credit markets, is the tension worth watching.

Historically, when the Fed has continued hiking into an already elevated rate environment, investors have focused on two things: whether corporate margins can absorb higher borrowing costs, and whether consumer spending holds up enough to keep revenues from falling. Neither question has a clean answer right now. Consumer sentiment is historically weak, yet credit markets are serene. Those two readings do not usually coexist for long.

Bottom Line: The case for another hike is built on one undeniable fact: inflation is still historically hot, and a 3.50%-3.75% funds rate may not yet be doing enough to change that. What happens to margins and credit conditions on the other side of that hike is the question the probability market does not answer for you.

Read more: CNBC Economy

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