Fed needs a 25-basis-point rate hike in September to restore credibility: Ed Yardeni

Ed Yardeni, President of Yardeni Research, expects the Federal Reserve to raise interest rates by 25 basis points in September, saying the move would help restore the central bank’s credibility on inflation. He says the Fed may need to do more depending on how inflation and the bond market react, with the next consumption deflator reading likely to be an important indicator.Yardeni also pushes back against concerns of stagflation in the US, saying domestic demand remains strong despite some weaker headline growth numbers.

He points to robust consumer and business investment demand and says the artificial intelligence boom has also distorted gross domestic product figures as imports of goods needed for the boom have surged.This is an edited transcript of the interview.Q: What is your big takeaway from Jackson Hole? Do you think Fed Chairman Kevin Warsh delivered a hawkish speech, and what does it mean for the Fed rate hiking cycle from here on?

A: You're right. It was a hawkish speech, but it wasn't really that surprising because when he did his press conference in June and again in July, he was also quite hawkish and said that the job of the Federal Reserve is to maintain price stability.He said that in June, and there was some disappointment that he didn't actually act in July. And now the question is, right now he's talking the talk of a hawk, but it's still not obvious that he's going to walk the walk.And, by the way, there are other members of the Federal Open Market Committee that have to vote.

And so far, what we know is there's definitely three dissenters from the July meeting who wanted to raise interest rates immediately, and it could be an interesting meeting up ahead here.I can't see that Warsh wants to be a dissenter. In other words, he doesn't want to be the fourth dissenter saying that they should be raising interest rates immediately. So, he's got some tough work to do to convince the committee to do what I think it does need to do, which is gain some credibility by actually raising the Fed funds rate by 25 basis points in September.

I think it's going to happen.Q: Do you think he needs to follow through with a December rate hike also? A: We'll see what the reaction is of the yield curve. I think that if he does a quarter point, we may actually see the bond yield go down, because what the bond market wants to see is that the Fed is, in fact, willing to be vigilant about inflation, not just talking about it, but actually doing something about it.The next inflation number that's going to be relevant here is going to be at the end of next month, another consumption deflator measure.

And so far, the Cleveland Fed, which monitors that situation, says that the number for August is going to be up 0.3%, which again keeps the year-over-year number over 3%. So, the Fed may very well have to do some more.Q: Some people have pointed this out, right? You have growth numbers which occasionally disappoint—I mean, the Chicago Purchasing Managers' Index is a case in point. You got inflation which continues to be slightly higher, a bit of a stagflationary kind of an environment.

Would you pay any credence to it? A: I hate to disagree, but not at all. I mean, Warsh himself said the economy is doing quite well. Maybe some of the top-line numbers. I mean, there are numbers that certainly confirm that scenario you just laid out, stagflation, but it doesn't look like that at all here in the United States.Watch the full conversation hereWarsh pointed out that private credit, private demand for goods and services is very strong.

It's growing more like 3% than 2%. The GDP number has been affected by the fact that we've got an AI boom, and we don't make everything we need for that boom.So, our imports have surged from South Korea, Taiwan, also from Vietnam, and that depresses GDP. So, when you look at the domestic demand in the United States, it's very strong, both consumers and investment demand, business investment.Catch all the latest updates from the stock market here