MNI INTERVIEW: Fed Cautious On Cuts Despite Disinflation-Misra

Federal Reserve officials are done raising interest rates but will take their time before cutting them as concerns linger that the path to getting inflation back to 2% will be bumpy, Priya Misra, former member of two key New York Fed advisory groups, told MNI.

“We are at an inflection point – the last Fed hike is behind us. The Fed thinks policy is in a good place,” Misra said in the latest episode of MNI’s FedSpeak Podcast.

“The bar for them to hike more is high – but I do think the bar for them to cut is also fairly high. In a soft landing, they’ll cut rates really reluctantly.” (See MNI POLICY: Fed Likely Done, Focused On Length Of Hold)

A fairly rapid and consistent decline in inflation this year has raised investor hopes that the Fed could begin easing by as soon as early next year. But Misra thinks markets are getting a little carried away about pricing in near-term rate cuts.

“We’ve been used to a Fed that’s been extremely preemptive, I think it’s going to be harder for them to be preemptive this time around,” said Misra, a managing director and portfolio manager at JP Morgan Asset Management, and previously a member of the New York Fed’s Alternative Reference Rate Committee as well as its Treasury Market Practices Group.

“If they really want to put the inflation genie back in the bottle, maybe they have to stay restrictive for a little longer.”

LAST MILE

She thinks the so-called “last mile” on inflation could be harder to achieve.

“Getting from 3 to 2, or 2.8 to 2%, that might be a lot harder for the Fed to engineer, with a very tight labor market. I don’t see inflation resurging but I think the straight line down, which we saw from 5.5% PCE to 4%, that decline slows down, the slope of that decline starts to peter out,” Misra said.

“That’s what’s going to make it hard for the Fed to respond, because if their target is at 2 and we’re at 2.6, that’s far off enough, and I don’t think they want to signal that it’s a little loose in terms of that 2%.”

HARD LANDING POSSIBLE

Markets may also have become overly sanguine about the prospect of a soft landing. Misra said the risk of a recession cannot be taken lightly.

“We are more in the camp that a hard landing is more likely than the market’s pricing in,” she said.

That’s in part because the lags of policy are long and significant, she said. This makes it important to track granular balance sheet data on businesses and consumers to gauge early signs of deterioration.

If the unemployment rate does jump sharply, the Fed’s reaction would probably be much more aggressive than the slow path of rate cuts currently priced into financial markets – about 200 basis points of cuts from the current 22-year high of 5.25-5.5% over a one to two-year period, she said.

“If you have a mild recession they might want to get rates into accommodative territory." That could see rates cut down to as low as 1.5-2% over a two year horizon, though even in that scenario, a reluctant Fed would likely not begin to lower rates until the second half of 2024, Misra added.