MNI INTERVIEW: Ex-Fed Carpenter Sees Additional Cuts In 2020

By Evan Ryser

     WASHINGTON (MNI) - The Federal Reserve will be forced to enter into another

cycle of rate cuts in 2020 as the impact of already-implemented tariffs feed

through the economy, despite the imminent consummation of a "phase one"

U.S.-China agreement, former Fed Board economist Seth Carpenter told MNI in an

interview.

     With slower growth likely for both the first and second quarters of 2020,

the Fed will have to cut the fed funds rate three times to a range of 0.75% to

1.00%, predicted Carpenter, former deputy director of the division of monetary

affairs at the Fed and former acting assistant secretary for financial markets

at the Treasury Department.

     Carpenter's view runs counter to the consensus view that 2020 will be

another year of trend-like growth and low unemployment. Markets are pricing in

only a roughly 16 basis point reduction in the fed funds rate over the next

year, and see a 95% probability that the Fed will keep rates steady in January

in a range of 1.50% to 1.75%.

     "Even with this trade deal, we think the tariffs that are already in place

now that started in June and September are working their way through the

economy. We see a pretty sharp slowdown in the first half of next year" and

annual growth at 1.4% in 2020, said Carpenter, now chief U.S. economist at UBS.

     A first-stage U.S.-China deal came just in time to avoid threatened Dec. 15

tariffs on $160 billion of imports, but, beyond that, the deal featured only a

minor tariff rollback, leaving duties on two-third of imports from China,

roughly $360 billion. President Donald Trump said Tuesday he will be signing the

deal with Chinese officials on Jan. 15 at the White House. 

     While Fed Chair Jay Powell has emphasized the Fed will hold rates where

they are barring a "material reassessment" to the outlook, Carpenter says:

"There's enough damage already in train that the slowdown in the first half (of

2020) will lead to that material reassessment."

     -- WAGE PRESSURES UNLIKELY TO LIFT INFLATION

     The unemployment rate will move up to 4.1% over the course of the first

half of next year, Carpenter said. 

     While average hourly earnings could be expected to remain steady in 2020 at

3.1% then edge up to 3.2% in 2021, there is very little causal link between wage

inflation and consumer price inflation, running counter to the Fed's narrative

that increased wages will eventually help inflation get back to the 2% symmetric

objective.

     The general notion of a tightening economy and labor market stretching to

meet rising demand will over time start to push up prices, Carpenter said.

     "It's overall demand for goods and services in the economy that ends up

bidding up prices," Carpenter said. "It's not the straight teleological link

from wage inflation to price inflation."

     -- AVERAGE INFLATION TARGETING

     The Fed is focused on low inflation and inflation expectations and the Fed

seems convinced that the current framework doesn't give them enough flexibility

-- or "force their hand enough" -- to allow them to treat 2% as a symmetric

target.

     While the Fed is not going to adopt a "very rigid quantitative route" or

price-level targeting, he said, they'll change their strategy to aim for 2%

inflation on average over time with an added clause that considers historical

shortfalls, "especially in so far as those shortfalls are affecting inflation

expectations."

     That will give the Fed "the courage of their conviction to let inflation

run a little bit hot," Carpenter said.

     Whether the framework review produces much is in the eye of the beholder,

Carpenter said. The framework review has come under scrutiny for not being bold

enough from former Fed officials such as former Minneapolis Fed President

Narayana Kocherlakota and former Fed Board economist Joseph Gagnon.

     Carpenter said a new framework with a greater emphasis on symmetry will

have ramifications. With such changes the Fed "probably would not have hiked in

2015 or 2016."

--MNI Washington Bureau; +1 202 371 2121; email: evan.ryser@marketnews.com

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