MNI INTERVIEW: Hawkish Fed Pause In Sept - Ex-Staffer Trezzi

The Federal Reserve looks set to deliver a hawkish pause at its September meeting and leave open the chance of an interest-rate hike later this year as core inflation lingers above target, former Fed Board and ECB economist Riccardo Trezzi told MNI.

Trezzi's Underlying Inflation consultancy sees trend prices running 2.5% to 3%, meaning talk of a rate cut is several quarters away. That's why Chair Jerome Powell's Jackson Hole speech last week took the tone of not declaring victory amid some softening, Trezzi said.

“The Fed cannot rule out a scenario in which inflation remains consistently above target, and this is making everybody nervous, and the bond market progressively more nervous,” Trezzi said Monday. “Jay Powell had to sound hawkish at Jackson Hole... he was trying to manage the uncertainty and the risks.”

China's recent slowdown isn't enough to overturn the balance of U.S. inflation risks according to Trezzi, who pointed to greater stickiness in domestic service prices. While America's economy needs some weakness to rebalance, it's still possible that can come without major pain in the job market, he said.

The Fed has raised rates over the last year-and-a-half from effectively zero to a 22-year high of 5.25-5.5%. Inflation has come down to a 3%-4% range, from a peak above 9% last summer.

A VERY GOOD EXCUSE

Investors should avoid getting too optimistic about easier policy based on a few more modestly supportive inflation reports given the bigger trend, he said. “It’s where the economy is going in a year or two from now, and unfortunately they still do not have the green light,” Trezzi said.

“The Fed is in a situation in which it can definitely pause in September and see because … the last couple of prints have been somewhat encouraging,” he said. (See: MNI INTERVIEW: Fed Right To Stay Open To More Hikes-Obstfeld)

Officials could back up the idea of a pause instead of a hike in September by suggesting the June dot plot estimate for core PCE inflation this year of 3.9% is too high, Trezzi said, saying it's more like 3.5% or 3.6%.

“It gives you a very good excuse in fact to just pause for a meeting,” he said. “But they will sound hawkish, and they will say that we are prepared to hike again if anything goes wrong, that nothing is on a predetermined path. But they could hike again in November or December.”

Finally, the Fed is likely to reject the idea of raising its inflation target at least until price gains are restored under today's system, he said. “You don’t really want to change your target before you get back to it because then your credibility is gone.”