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MNI: Ex-Officials Now See Fed Rate Peak At 5% Or Higher
Federal Reserve policymakers will likely be forced to raise interest rates more than their own forecasts suggest because of persistent inflation pressures, but the time still may be nearing for the central bank to slow the pace of those rate increases, former Fed officials and economists told MNI.
The FOMC in September said rates were likely to rise to 4.6% by the end of next year, but sticky inflation and rising core services prices raise the chances the fed funds rate might need to peak above 5%, they said.
The September CPI reading "reinforces that conviction of tightening and might lead you to think about maybe an extra 25 basis points at one meeting or another," said Steven Kamin, former director of the division of international finance at the Fed Board.
The Fed has lifted rates by 0.75 percentage point at each of its past three meetings, bringing its benchmark federal-funds rate to a target range of 3% to 3.25% last month — the fastest pace of increases since the 1980s.
"Could they get to 5% or above? Absolutely," said former Boston Fed senior economist Jeff Fuhrer. "They made a change of about a percentage point (to rates projections) at the September meeting. With one additional bad CPI report, the market is notching things up further."
Eric Swanson, a former senior economist at the Fed board, says the Fed's 4.6% median estimate for peak rates is "beginning to get more realistic" but still likely underestimates the terminal fed funds rates in this cycle. "There really is no sign that core inflation is coming down yet."
Kamin said the Fed's communication should continue to focus on inflation despite market and economic risks. In 2018, he co-chaired a BIS report warning about lower-for-longer interest rates encouraging excessive risk-taking in pension funds and others and that there could be liquidity problems if there were a quick snapback in interest rates.
The Fed raising rates so much that it pushes the economy into a deep recession or into a financial crisis is a possibility and a risk, he said, but it is in the Fed's interest to ignore those risks in public for now and instead focus on fighting inflation. (See: MNI INSIGHT: Fed Sees Fin. Stability As Separate From Rates)
The Fed is "okay with disappointing the market on the upside because that enforces their hawkish credentials, but they would be very cautious about disappointing on the downside," said Kamin.
Former Boston Fed President Eric Rosengren agreed a resilient economy, sticky inflation, and a strong labor market are reasons why the Fed will raise rates above 5%. (See: MNI INTERVIEW: Another Fed 75BP Hike Likely In Dec.-Rosengren)
The Fed will "want to see more progress on trimmed mean measures of CPI and PCE so that it really looks like inflation is starting to come down -- not that it's just expected to come down," he said, adding it is likely there will be no stepdown to a slower pace of hikes in December.
TIMING THE DISMOUNT
The former Fed officials unanimously agreed a fourth 75 basis point move was likely in November, and a fifth supersized move could happen in December. A minority argued against the prospect.
Nathan Sheets, also a former international finance division director at the Fed Board, said the Fed will need to soon reduce its pace of rate hikes.
"At some point they've got to say: It's about the level of rates, and now we've moved substantially. This is a smaller move than 75 basis points but it's adding to an increasingly tight monetary policy position," said Sheets, now global chief economist at Citi. "How to balance a smaller rate hike or even a pause with a narrative that we are vigorously fighting inflation is a big challenge. They need to dismount and I think they'd prefer for that dismount to not be too abrupt."
Joseph Gagnon, a former Fed Board economist, said leading indicators like supply chain measures, new rent prices and used auto prices have started to turn.
"If we can avoid a rail strike and wage growth stays moderate, core inflation may start to cool soon. I think the Fed will slow down quickly when that happens," he said.
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