MNI: Fed Keeping 50 BP Option Open For Later -- Ex-Staffers

The Federal Reserve is set to lift off from its near-zero setting with a quarter-point interest rate increase in March but 50bp hikes later this year are under consideration as inflation pressures worsen, former central bank staffers told MNI.

The war in Ukraine is pushing up energy and commodities prices at a time when U.S. inflation continues to surprise to the upside. The Cleveland Fed's nowcast expects February CPI to accelerate by three-tenths to 7.8%, which would be a fresh 40-year high for the index.

"There is an institutional bias towards doing things at a steady pace and that suggests a series of 25-basis point hikes," said Kenneth West, a University of Wisconsin economist who's been a visiting scholar at several regional Fed banks.

However, "one factor that keeps inflation expectations anchored is conviction, and confidence that the Fed is committed to not letting inflation get out of control, so floating doing 50bp later is part of that," he said. Dovish Fed officials, such as Mary Daly of San Francisco, have said a 50bp move may be needed at some point down the road.

EXPECTATIONS RISING

The Fed tends to look through oil price shocks in assessing the likely path for inflation a year from now, said Evan Koenig, former principle policy adviser at the Dallas Fed, but household inflation expectations are sensitive to gasoline prices, exacerbating the current high inflation environment. The conflict in Ukraine only heightens such concerns.

"Now is not a time when we want to see additional upward pressure on expectations," Koenig said, noting a key internal measure of trend inflation, the Dallas Fed's trimmed mean measure, that jumped to 3.5% in January and likely has room to rise.

"Whether you look at the gap between headline and core inflation, the trajectory of the overall economy, or the labor market, there's no obvious reason that inflation pressures will wane any time soon," he said. "The FOMC has found itself pretty far out of position in this cycle and is scrambling to put policy closer to where it needs to be."

With a long way to go on rates to restrain the economy, the former officials question whether consecutive 25bps hikes is fast enough -- but also worry over the rising risk of recession if the Fed is too aggressive.

OPTIONALITY

Charles Goodhart, a former Bank of England official whose work on inflation has been cited by Fed Chair Jerome Powell, warned that the U.S. economy is entering a wage-price spiral and said the Fed should move rates up to near-2% this year.

"I would really go for really quite a lot of 25bp increases" with the possibility of adding in a single 50bp increase, Goodhart said. "A whole series of 50bps -- my worry is that it would drive the U.S. economy into an undesirable recession and financial markets into a total tizzy."

Nathan Sheets, former international finance division director at the Fed Board and now global chief economist at Citi, finds the case for 50bps in March "compelling," given the distance to neutral in real terms. The February CPI report, to be released in the middle of the Fed's media blackout just days before the FOMC meeting, "is likely to strengthen the hand of those advocating more aggressive action." he added.

Whether the Fed hikes 25bps or 50bps in March, "the critical issue is that they not establish an expectation for tightening no faster than 25bps per meeting, which could leave them further behind the curve," said Bill Nelson, chief economist at the Bank Policy Institute and former deputy director of the Division of Monetary Affairs at the Fed Board.