MNI INTERVIEW: Blinder Sees Fed Rates At Peak For About A Year

The Fed is set to keep interest rates at the cycle peak for about a year after deciding whether resilient data merits a final hike or whether the recent spike in yields has sufficiently tightened financial conditions, former Vice Chair Alan Blinder told MNI.

"My guess is either they’re finished now or maybe, depending on incoming data, they go up another 25 basis points and then hang around that rate for a substantial period of time. I wouldn’t be shocked if it was for a year," Blinder said in an interview. "That’s stabilizing the rate."

Booming GDP growth in the third quarter also strengthens FOMC hawks but the U.S. economy is expected to slow dramatically in the fourth quarter and the surge in inventory build-up through September could be a bearish signal, he said.

His view of a long pause after rates peak is in line with the FOMC's September dot plots showing perhaps one more hike this year to about 5.6% and a decline next year to 5.1%. Those projections don't reflect the recent surge in bond yields.

Higher yields should ease policymaker worries they haven't been forceful enough to bring inflation to heel, because the bond market has done more, Blinder said. "Even the more hawkish members of the committee are talking about two-sided risks now."

The 10-year Treasury yield topped 5% this week, the highest since 2007. Driving that rise isn't any nebulous compensation traders require to hold longer-dated securities, Blinder said. "It's substantially due to the market finally caving to the Fed saying don’t expect rates to fall right away," he said. "That’s a belief that finally creeped into traders' minds. They were resisting it for quite a while."

INFLATION DYING ON THE VINE?

Before Fed Chair Jerome Powell can arrive at any consensus on rate cuts next year, he must convince the hawks that inflation is down for the count, Blinder said. That means "either we're at 2% or really close to it," he said. While PCE inflation has slowed to 4.0% from 7.7% at highest, it remains well above the Fed's 2% target, especially compared with the era before the pandemic.

"Do we have the real rate high enough for long enough that inflation is going to die on the vine? They’re not there yet." (See: MNI INTERVIEW: Disinflation Stall Could Push Fed To 6% Or More)

Decelerating inflation alongside a job market strong enough to keep unemployment less than 4% for nearly two years remains a mystery, Blinder said. "By traditional Phillips Curve thinking, it shouldn’t be happening," he said. "But it’s gone on for a while, and that makes you think maybe there's something permanent about it." (See: MNI INTERVIEW: Fed Likely Done With Hikes Despite Hawkish Tone)

The longer the "immaculate disinflation" continues, the higher the probability of a soft landing, he said, putting the odds at about 2-to-1. "Months ago it was the reverse. That to me is a big change."