MNI INTERVIEW: Another Fed 75BP Hike Likely In Dec.- Rosengren

The Federal Reserve likely needs to push rates higher than officials had expected as recently as last month's meeting because inflation remains stubborn even in the face of substantial moves to wrestle it under control, and policymakers will likely resort to a fifth straight 75 basis point hike in December, former Boston Fed president Eric Rosengren told MNI.

While the central bank in September had penciled in a peak rate of 4.6% next year, that is likely to be nudged up above 5% in the central bank's next forecast to be released in December unless data shows inflation surprising to the downside before then, he said.

"To date, they have not seen substantial progress towards bringing the inflation rate down and they're not seeing substantial improvement in bringing the wage rate down either. Until they start actually seeing a clear turn in measures of inflation, I think it's going to be hard not to continue to raise interest rates higher," he said, noting that trimmed mean measures of core CPI and PCE inflation are still going up.

SURPRISINGLY RESILIENT

"What's interesting is that the economy's proven to be much more resilient to the interest rate increases we've seen to date than I might have expected," he said. "The challenge for the Fed is that it's an environment where the interest rate increases that have occurred to date don't seem to be having the desired effect of shrinking demand enough to bring inflation down particularly quickly."

Rosengren said there is a "very high probability of a recession next year" that's going to be a mild "monetary-induced recession." He furthermore pressed against the notion the Fed could raise rates at a slower pace starting in December, acknowledging the most recent SEP median points to 125 basis points of further tightening this year with the base case of a 75 basis point hike in November and a 50 basis point increase in December.

The Fed has said "they want it to be sufficiently tight that they see meaningful progress towards bringing inflation down," Rosengren said. "So if that's truly the criteria they're using, I don't think they've met that standard."

"The risks are that they will have two 75 basis point increases rather than a 75 and 50," he said. "The base case of 75 and 50 is actually requiring some pretty good CPI and PCE reports before the December meeting, and I'm not sure they're going to get that."

Rosengren, now a visiting professor at MIT, expects little guidance at the November FOMC meeting going forward and more emphasis on data dependence. The unemployment rate is still at an historically low 3.5% with wage growth at around 5% substantially more than what's needed, he said, pointing to labor markets as another source of persistent inflation. Rosengren sees unemployment rising above 5% next year.

"The fact that we're not seeing more slack in the labor market at this stage makes it hard to see how nominal wages are going to drop fast enough to meet the kind of inflation path that the SEP currently has," he said, adding that wage growth needs to fall to at most 3.5% especially since productivity has not held up well recently.

SHELTER

Rosengren said there has been more persistence in inflationary components than expected, in particular pointing to shelter and rents. While some on Wall Street have sounded optimistic in pointing out rents falling for new contracts, Rosengren said there's a lot of persistence.

"To the extent that shelter is growing much more rapidly than 2% it means it's going to be much harder for the Fed to quickly get down to a 2% inflation target." (See: MNI INTERVIEW: Entrenched U.S. Inflation To Linger-Fed's Meyer)

The Fed has to be worried about people's expectations becoming embedded that inflation is going to be well above 2% for much longer than they're predicting in the SEP, he said, again pointing to wage-setting behavior. "There's general skepticism that inflation is going to come down as easily as the Fed seems to think."