MNI INTERVIEW: Fed Could Cut As Early As June - Quarles

Financial stability stresses could prompt the Federal Reserve to cut by June despite the resilience of the economy, former Fed Governor Randal Quarles told MNI.

Quarles, a former top banking regulator and Fed vice chair for supervision, expects financial conditions to tighten as the year progresses, allowing the Fed to begin a gradual easing campaign, likely to fall short of market expectations.

"It really will depend on how inflation performs but particularly how labor market measures proceed along the course of realignment," he said in an interview. "My own expectation would be, in part because some of this could be accelerated due to some financial stress, I think interest rates could start coming down in June."

"The Committee will begin to come down probably backloaded towards the end of the year, not as far as people are expecting and not as soon as people are expecting," Quarles said, suggesting he sees closer to only two 25 basis point cuts this year. A hotter-than-expected consumer price index showing inflation of 3.1% in the year to January reduced market pricing to under 100 basis points of cuts through the year.

"I continue to think that for inflation to be constrained, you have to rein in the economy more than has been done. I think that translates into a short and shallow recession at some point," said Quarles, now chairman and co-founder of The Cynosure Group, a Utah-based investment firm. (See: MNI INTERVIEW: Hot US Economy Complicates Fed Cut Calculus)

FINANCIAL PRESSURES

"What is clear is that the economy has to come in further than it has and I believe that that will happen this year driven in some good part by further pressures on the financial system. That is a dominant transmission mechanism of monetary policy into the economy, which is that you constrain the financial system.”

Shares of regional banks were hit hard by Tuesday’s inflation data, raising more concerns about potential fallout to commercial real estate from interest rates at their current relatively elevated levels.

"Those pressures popped up last spring and they have remained over the course of the year, although I don't see any serious financial instability," Quarles said.

"It should be expected that that has not eased. Given that interest rates haven't come back down, all of those pressures are out there," he said. "I think they're probably going to be bigger in the non-bank sector, where we have less visibility, than in the bank sector.

"I'd expect more news about pressures in the financial system over the course of the next six months. That leads to further tightening of financial conditions, further constraint in the economy, further adjustment in labor measures, and that sets the stage for the Fed to say, 'Okay, now we're confident enough that we can begin lowering rates,'" said Quarles. "That's likely in the second half of the year." (See: MNI: Fed Will Wait On Rate Cuts In Strong Economy-Stevenson)