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(Repeats article first published on Feb. 11)
The Federal Reserve is likely to begin raising rates in March, probably by 25 basis points, and follow up with hikes in the next few meetings, but signs that tighter policy is hitting the labor market could prompt a mid-year pause, former Fed officials and staff told MNI.
"They are going to be quite sensitive to the unemployment rate," said Tom Hoenig, former Kansas City Fed President. "If they start to hike rates and after three times they see unemployment start to rise they will hesitate and they will have to think about it carefully. They may then pause, even if inflation stays elevated."
"They have a very tough needle to thread," he said in an interview with MNI. "They are much more inclined to watch that unemployment number than people otherwise suspect. They are watching it very carefully, every bit as closely as they do the inflation numbers."
The U.S. Thursday reported CPI inflation quickened to 7.5% in January from a year ago following December’s 7.0%, the fastest since 1982. Some sources saw continued upside risks to prices in the near term, at least until further improvement in supply bottlenecks, adding to the case for measured hikes through the first half of the year.
Markets moved to price in a strong chance of a 50-basis point hike, a market shock the Fed would prefer to avoid and a step that, so far, only James Bullard of the St. Louis Fed said he favors in a Bloomberg interview.
"I got the message that they are front-loading, in perhaps three consecutive hikes, rather than spreading them out," said Gerald Cohen, an ex-New York Fed economist and former deputy assistant secretary at the Treasury Department. "Clearly the risks are that inflation and inflation expectations become unanchored and that's the reason to continue to talk aggressively and act pragmatic."
Still others saw the potential for a steadier rate path to near-neutral. "My recommendation is that the Fed should announce that it intends to level step back to 150bp … over a few meetings and will then pause, observe the evolution of the data and adjust policy in a data-dependent manner from there," said Krishna Guha, a former New York Fed executive vice president, adding he is "not sold" on a 50-basis-point hike in March. A level of 1.5% would be the low end of a wide range of potential neutral settings for the Fed, he said.
Looking ahead to the summer, some sources saw the potential for easing supply issues, coupled with a shift in household consumption toward services, that could lead to lower annual inflation for core goods, potentially opening the door to a more gradual rate path later this year.
Mary Daly of the San Francisco Fed told MNI she saw interest rate increases in March and subsequent meetings and cautioned against acting too aggressively. Lorreta Mester of the Cleveland Fed said Wednesday that if inflation falls faster than expected, then the pace of hikes could be slower in the second half of the year.
"The cure for high inflation is higher interest rates, but higher interest rates also risk derailing the recovery," said Peter Ireland, former Richmond Fed economist. "The challenge for the Fed this year is going to be raising rates quickly enough to bring inflation back down but without putting in jeopardy the continued recovery."
The Fed is likely to wait for the supply side to catch up to demand, some said.
"The Fed is right to be patient through as much of this as they can to allow supply to expand to the extent possible before choking off demand," said Tara Sinclair, a former visiting economist at the St. Louis Fed.
"I would be very surprised to see this particular FOMC go for that shock and awe 50-basis-point hike in March and I think one of the key reasons is that there's still a substantial perception that supply can expand," said Sinclair, who sees a series of Fed hikes coming. "We don't want to choke off demand to where we can't meet that expanded supply once the virus really fades into the background."
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