MNI: Fed In Holding Pattern As Inflation To Stay High-Ex-Staff
MNI (WASHINGTON) - The Federal Reserve is likely to keep interest rates on hold for the remainder of the year as strong growth and the threat of trade wars keep inflation too high for comfort, former Fed economists told MNI.
“We’re in a holding pattern for this year unless something dramatic happens,” Joseph Haslag, a former Dallas Fed economist, told MNI.
Chair Jerome Powell told Congress this week the Fed is in no hurry to lower interest rates further after reducing them by 100 basis points at the end of last year. While Powell indicated that monetary policy is still restrictive, Haslag and other ex-Fed staffers believe last year's cuts have likely already brought the federal funds rate, now in a 4.25%-4.5% range, closer to its neutral level.
“Right now we’re probably in the neutral zone. I think we’ve lowered rates to a point where monetary policy is neither deflationary nor inflationary,” Haslag said.
PRICE FLARE-UP
The January CPI came in much stronger than expected this week, with a 0.5% gain on the month raising concerns about a possible reacceleration of price pressures, particularly as firms and consumers brace for tariffs from the Trump administration.
“All the risks are in the direction of more inflation,” said Joseph Gagnon, former Fed board economist. “There’s lots of uncertainty and who knows how the trade war, deportations, and fiscal policy will unfold.”
Price pressures were simmering even before Trump took office, given continued strong nominal spending growth, said Evan Koenig, former principal advisor at the Dallas Fed. Supply-side boosts, including higher labor market participation, a post-Covid rebound in productivity and the surge in immigration during the first three years of the Biden administration, had previously kept prices in check but were unlikely to persist, he said. (See: MNI: Fed's Inflation Fears Back On Rise, Even Before Tariffs)
"Trends in nominal spending provide no grounds for optimism that further progress in lowering inflation is in the cards," he said.
Slower immigrant inflows suggest a step down in the economy's real growth potential and consequently a step up in the rate of inflation consistent with any given rate of spending growth, Koenig said.
LESS RESTRICTIVE
Former Fed economists cite ever-larger deficits as a key driver of higher neutral rates over time. The median estimate of the longer-run fed funds rate on the FOMC has climbed 50 bps to 3.0% over the past year,so rates still have some ways to go before reaching that threshold. (See MNI INTERVIEW: Fed Rates Likely On Hold Through 2025)
Policy wildcards from the Trump administration are a major hurdle for the additional easing that the Fed would otherwise be doing, Gagnon said.
“If we were on the previous path and just extended Trump’s tax cuts and nothing else, I would expect the Fed could resume cuts later this year but only to around 3.5%,” he said. “I think neutral is already 3.5% and could go higher in a world with prolonged large fiscal deficits."
Former Fed board governor Randall Kroszner told MNI's FedSpeak Podcast last week that policy uncertainty would likely prevent any rate cuts for most if not all of this year.
Any debate about rate hikes remains off the table for now, ex-staff said, particularly given the majority FOMC view that rates are still restrictive.
"I don't imagine that there's much appetite among policymakers for raising the funds rate target absent a clear upward movement in a broad range of core inflation measures or a significant tightening of labor-market conditions," Koenig said.