MNI INTERVIEW: Fed Could Cut By May, Inflation Lingers-Kaplan
The former Dallas Fed president says a soft landing is coming at too steep a cost -- dangerously high debt levels.
Federal Reserve officials will wait until May or later to begin cutting interest rates because they’ll want to see more benign inflation figures before kickstarting a monetary easing cycle, former Dallas Fed President Robert Kaplan told MNI.
“They need to see continuing evidence that the improvement in inflation is going to be durable and sustainable. It’s prudent to take a little more time,” Kaplan said in an interview. “I still haven’t ruled out that this could happen in May if you get continued inflation reports that suggest progress.”
Kaplan described the Fed as a slow-moving “super-tanker” that inches gradually toward major decisions – like when to begin reversing two years of aggressive monetary policy aimed at fighting the worst inflation since the 1980s.
Fed Chair Jerome Powell told reporters at his press conference last week “it's a highly consequential decision to start the process of dialing back on restriction. … We just want to make sure that we do get the job done in a sustainable way.” (See MNI INTERVIEW: Fed Overtightened But Will Wait 'Til May To Cut-Harvey)
Kaplan said a strong and persistent impetus to the economy from fiscal spending raises the risk that inflation will either stabilize above levels consistent with price stability or even reaccelerate, particularly if combined with some kind of geopolitical shock.
FISCAL BOULDER
“We’re at full employment and running historically high deficits as a percentage of GDP. That government spigot means that for the rest of this year surprises are going to be on the positive side,” Kaplan said.
“It’s like dropping a boulder in a pond and then you watch the ripple effects. If I were at the Fed, it would put me more on guard to make sure we don’t have an acceleration and I’d be watching the goods sector and the service sector, which is impacted by projects around the country.” (See MNI INTERVIEW: U.S. Manufacturing Nearing Growth Phase-ISM)
Kaplan also believes an ageing population and slowing workforce growth, in addition to the fracturing of global trade and supply chains, likely mean inflation is structurally higher than it was before the pandemic.
“There is sand in the gears of globalization and that means things are more expensive,” he said. “I would be most worried that decelerating workforce growth means wages, specifically in the service sector, are going to be stickier.”
HIGH COST OF SOFT LANDING
Kaplan fears the economy is paying a high price in order to potentially achieve a vaunted soft landing – dangerously high debt levels that are even restricting the Treasury's ability to issue debt at longer maturities.
“It matters how you achieve a soft landing. If you told me we were achieving the soft landing by going from over 100% debt to GDP, interest expense in the budget is on its way to USD1 trillion, and we are hesitant at the Treasury to offer in 10- and 30-year supply, and it’s only going to get worse in the next couple of years, and that’s the price of this soft landing?,” said Kaplan.
“We might have been better off with a further slowing. Unemployment might go up some, you’d have lower inflation, you’d have lower interest rates and I think it might be a healthy readjustment. We’ve got a very significant fiscal situation.”
The Fed left rates on hold at 23-year highs of 5.25-5.5% for a fourth straight meeting, but also altered the language of its statement to convey a more neutral forward guidance that opens the door to interest rate reductions later this year.
Powell also pushed back against the likelihood of a March cut, saying: “I don't think it's likely that the Committee will reach a level of confidence by the time of the March meeting to identify March as the time to do that.” He repeated that message in an interview with 60 Minutes Sunday.