MNI: CPI Shortens Odds Of 75-BP Hike In Sept-Ex Fed Staffers

Some former Federal Reserve economists are nudging up their estimates for where interest rates will peak this cycle to above 4% after inflation picked up speed in June, despite a more recent retreat in commodity prices and mounting recession risks, ex-staff told MNI.

Whereas most ex-Fed staff until recently saw an FOMC preference to downshift to a 50-basis-point rate increase in September after a second straight 75bp hike this week, some now say a hawkish recalibration may be in store to arrest inflation momentum. That could mean a third 75bp move, and a higher eventual end-point in this hiking cycle.

"I view the June dot plot as a lower bound on where the fed funds rate will be, because the SEP is conditioned on too optimistic a course for inflation," said Vincent Reinhart, a former director of the division of monetary affairs at the Fed Board. Fed officials in June saw interest rates rising to 3.4% by year-end and as high as 3.8% in 2023.

Many economists thought inflation had peaked until June CPI came in at a stronger-than-expected 9.1%, a 40-year high.

SEPTEMBER GUIDANCE

Ellen Meade, former senior adviser at the Fed board, now says interest rates could peak around 4.25% over the cycle, which would match the high end of the range of Wall Street estimates.

She expects Chair Jerome Powell this week to repeat guidance from June for "either a 50-basis-point or a 75-basis-point increase" at the next meeting, but, with only two more CPI reports between now and September to gauge improvement, it will be a close call on the two options. (See MNI INTERVIEW: Firms' Price Expectations May Be 'Unanchoring')

"Earlier it looked like maybe they would be downshifting in September, and based on inflation data it does look like it is going to be harder," Meade said.

William English, a former director of the division of monetary affairs at the Board and secretary to the FOMC, agrees the rate path is inching up and suggested 4% could be breached next year. "If you had people write down an SEP for this meeting, the dot plot would be a little bit higher."

"The economy is very strong and inflation is very high, and so they're going to tighten policy a fair amount until they think they're going to get some slack in labor markets," English said. "They don't really have the ability to kind of move slowly and test."

RECESSION RISKS

The more hawkish sentiment was not universal. Some former Fed staffers offer more cautious takes on the rates path that are more in line with futures market pricing, citing dramatic slowing in housing and early signs of cooling in the labor market with initial jobless claims trending gently upward and the unemployment rate flattening out at 3.6%.

"After another 75bps at this meeting, they won’t be done but they don’t have all that far to go," said David Wilcox, former research director at the Fed Board and economist with the Peterson Institute for International Economics and Bloomberg Economics. He sees the FOMC hiking by 50bps in September followed by two to three more 25bp increases.

"By stretching out the remaining increases for the funds rate they will gain some time to gather further evidence about how much restraint their policy moves are imposing on the economy," Wilcox said.

ABOVE NEUTRAL

Powell said last month he does not expect 75bp rate increases to be common, former Philadelphia Fed adviser Luke Tilley noted. "The stronger argument there is that they want to get back to what they think of as neutral, between 2% and 2.5%. I think for them a slowdown from 75 basis points is already baked in."

As the fed funds rate target crosses the FOMC's median estimate of neutral at around 2.5% and moves into restrictive territory this fall, ex-staff expect the central bank to turn more cautious in its next policy moves, particularly as financial conditions could put the economy on lower growth trajectory more quickly.

"Once you get in the ballpark of the neutral range it's not that you want to stop," said Meade, now at Duke University, "but you want to be a little careful as you're moving for further tightening."