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MNI INTERVIEW: Fed Could Hike Rates More Than Expected-Hoenig
Former Kansas City Fed President Thomas Hoenig told MNI the U.S. central bank might need to raise interest rates more than investors expect because demand remains strong and monetary policy is still loose compared with the rate of inflation.
The FOMC will hike rates at least twice more in quarter-point increments, but might need to go even further if the data do not cooperate -- particularly on employment, Hoenig said.
“If they get strong jobs numbers continually then they probably will have to push rates higher than people had anticipated and increase the risk of a downturn,” he said. “Now that the market is more convinced that inflation is more embedded than even it thought, the Fed is going to have to be determined if they’re going to hold on to their credibility.”
Employment and inflation data over the past month prompted investors to price in a higher peak fed funds rate around 5.3%. The economy generated more than half a million jobs in January while the latest readings on both CPI and PCE pointed to underlying strength in inflation.
“The job numbers left them wondering whether inflation is going to come down as quickly as they had hoped.”
The Fed's rate hikes have yet to catch up with the rate of inflation, which helps explain why the economy is still humming along despite the aggressive tightening so far.
“Policy is not restrictive in a real interest rate sense. Everything feels fine because rates are negative and the market is convinced the Fed will reverse course and therefore financial conditions have eased,” Hoenig said.
“All that has to work its way out and then you get to the real world positive interest rates, slowing economy, then you’ll see the greater risk of recession.” (See MNI INTERVIEW: Fed Hikes Just Starting To Weigh On Jobs-KC Fed)
Even when the fed funds rate, now in a range of 4.5% to 4.75%, does surpass the rate of inflation, it will take time for that stance to begin dragging down economic activity.
“The last time rates were moved up systematically and then moved positive it took several months after that for the real effects to take place. So if you’re talking about mid-year, late spring or summer for real rates to become positive, then you’re more likely to have a recession that follows that, maybe late in 2023 or early 2024,” Hoenig said.
Investors doubt the Fed will follow through with restrictive action because policymakers have loosened in the past when the economy shows some weakness, he said. Even with a recent jump in yields as officials hammered home the message they must keep hiking, rates on two-year Treasuries remain higher than for debt due in ten years.
Hoenig thinks inflation will be sticky because what started primarily as a supply shock now has a significant demand component to it, fueled in part by the large monetary and fiscal support that followed the pandemic.
“There’s a lot of demand-pull capability in the economy and that’s why inflation will stay higher than they anticipate now that supply issues have become less of a factor,” he said.
“People are now getting used to the idea of higher prices, they’re kind of anticipating that, so as you get that embedded, it feeds on itself," he said. "That’s why the Fed may end up going further than people think. Inflation expectations are not as well contained as they would like it to be.”
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