Lü Shao-Wei Column: With More Variables, Jerome Powell Faces Risk Choices Amid Market Fluctuations

This week, the U.S. Federal Reserve (Fed) will hold its interest rate meeting. After last Friday’s release of the latest inflation data, market expectations for a rate hike have risen from 60% to 80–90%. Unlike in the past, this potential rate increase has broader implications—impacting everything from global exchange rates and U.S. Treasury yields to political sensitivities. Jerome Powell must now make difficult choices amid these competing risks.

Last month, Powell delivered a speech at the annual Jackson Hole symposium, where central bank governors from around the world gathered. His remarks were interpreted as 'hawkish.' He stated, 'There should be no misunderstanding: the Fed’s price stability target is 2%, measured by the Personal Consumption Expenditure (PCE) index, and this goal is firm and fixed.' He added, 'Inflation remains above the 2% target. Therefore, the Fed’s primary focus right now is on price stability.'

These comments caused the market’s expectation of a September rate hike to jump from 35% to 62%. Moreover, those who previously doubted whether Powell could maintain the Fed’s independence began to express confidence. Martin Wolf, chief economics commentator at the Financial Times, published an article titled 'Powell Might Make a Good Fed Chair,' expressing his approval.

From an economic performance standpoint, the Fed indeed has justification for raising rates. Typically, the main concern with rate hikes is economic contraction—slowing growth and, more importantly, harming the labor market. Fortunately for Powell, such concerns are minimal. The U.S. GDP growth rate in Q2 was 2.1% year-on-year—not outstanding, but solidly moderate. Supported by the AI investment boom, the economy is expected to maintain healthy momentum.

More crucially, the labor market remains stable. Unemployment hovered around 4.3% in March and April but has since declined. By July and August, it had dropped to 4.1%. In August, non-farm payrolls increased by 162,000, exceeding market expectations. Initial jobless claims fell to 206,000, indicating low corporate layoffs and a resilient labor market. This allows the Fed to raise rates with few concerns about economic fallout.

Friday’s price data further strengthened the case for a rate hike. On Thursday, the U.S. Bureau of Labor Statistics released the August Producer Price Index (PPI), which rose 0.4% month-on-month—the largest increase since May—and 5.4% year-on-year. Core PPI, excluding food and energy, rose 0.2% month-on-month and 4.6% year-on-year.

These figures carry several implications. PPI is often seen as a leading indicator for the Consumer Price Index (CPI). When production costs (PPI) rise, businesses eventually pass these costs on to consumers. Though there’s a time lag, PPI movements typically precede changes in CPI by several months.

Second, the PPI increase was primarily driven by higher energy prices, rooted in geopolitical tensions from the U.S.-Iran conflict. Additionally, supply chain disruptions and reconfigurations caused by geopolitical instability and Trump-era tariffs have contributed to upward price pressure. These factors are expected to persist in the near term.

After the release of August’s CPI, the likelihood of a rate hike became even harder to deny. The CPI rose 0.4% month-on-month—the largest gain since May—with a year-on-year rate holding steady at 3.4%. Core CPI rose 0.3% month-on-month (above expectations), while the annual rate dipped to 2.4%. Due to energy price rebounds and persistent inflation, market expectations for a Fed rate hike this month surged past 90%. Rising inflation—or at least its lack of moderation—combined with the European Central Bank’s recent 25-basis-point hike (its second consecutive increase) and oil prices climbing above $100, has further solidified the Fed’s rationale for tightening.

However, this Fed rate hike affects more than just domestic policy. Its impact on the U.S. Treasury market is particularly concerning.

U.S. government debt has surpassed $40 trillion. Due to inflation, growing debt, widening budget deficits, and declining demand from geopolitical factors, long-term U.S. Treasury yields have climbed above 5.3%—a 20-year high. Treasury Secretary Besent’s attempt to stabilize the market through a 'buyback' strategy failed. Last week, he increased the buyback amount to $6 billion, yet yields rose further.

The U.S. now spends more on annual interest payments than on its defense budget, risking entrapment in an unsustainable debt spiral. A Fed rate hike would exacerbate this situation.

Rate hikes also affect exchange rates, especially in Japan and China. The yen has been weak for a long time, recently depreciating to nearly 164 per dollar. After joint U.S.-Japan intervention, it has recovered to around 154. A U.S. rate hike could push it lower again. Japan’s only countermeasure may be to raise rates. Markets expect the Bank of Japan (BoJ) to hike by 25 basis points this week to offset U.S. tightening.

Regarding China, the U.S. recently urged RMB appreciation at the G20 finance ministers’ meeting. However, a U.S. rate hike strengthens the dollar and puts downward pressure on the yuan—a result neither the U.S. nor China wants. Further RMB depreciation could deter investment and trigger capital flight. Even if exports and trade surpluses increase, it may spark more trade disputes. Thus, Chinese authorities may need to gradually guide the yuan upward—or at least halt further depreciation.

The 'political nerve' refers to Trump’s relationship with the Fed. Trump is a staunch supporter of low interest rates and has repeatedly called for cuts. With November’s midterm elections approaching, Republicans are struggling, and the U.S. bond market is under yield pressure. If the Fed hikes rates, will Trump launch another political attack on Powell?

Of course, not hiking is also a choice—but it could erode market trust in Powell and the Fed’s independence. For Powell and the Fed, this would be an even worse outcome. Between hiking and holding, both options carry risks. The question is how Powell will choose.