MNI INTERVIEW: Fed Could Hike Rates Three More Times-Kaplan

The Federal Reserve could be forced to raise interest rates three more times if services inflation remains stubborn, and then to keep borrowing costs elevated longer than many investors expect, former Dallas President Robert Kaplan told MNI.

“It wouldn’t shock me that we got at least a couple more moves at the Fed and if this continues they may feel the need to do a little bit more,” Kaplan said in the latest episode of MNI’s Fedspeak Podcast.

Ripple effects from fiscal policy such as post-Covid stimulus and the Inflation Reduction Act are acting as a countervailing force to the Fed’s aggressive monetary tightening, Kaplan said. That’s keeping employment high and giving consumers enough cash despite the inflation challenge to feel comfortable spending, particularly on services.

“I was strongly in favor of a pause to assess these cross currents," Kaplan said. "However, as we get beyond this, services are going to stay strong. Even if I were at the FOMC when I got to the July meeting and the September meeting, I’d be starting to think we’re going to have to do more.”

The Fed this month kept official interest rates on hold for the first time since March 2022 after raising rates by some 500 basis points in just over a year. But policymakers also sharply revised higher their views of the likely peak federal funds rate to 5.6%. Fed Chair Powell told an ECB panel this week the central bank is strongly considering additional tightening and might not even shy away from consecutive rate moves.

HIGHER FOR LONGER

Kaplan said the Fed’s commitment to keep interest rates “higher for longer” might even be more important for investors than the ultimate top level of borrowing costs. (See MNI INTERVIEW: Fed’s Bostic Wants Rates On Hold Until End 2024)

“Rates are going to have to stay at this level longer than is probably reflected in the yield curve,” he said. "The length of time you’re at this level in my opinion will matter more than whether the terminal rate is 5-¼, 5-½ or something more than that. There are people that may be making economic decisions right now thinking the Fed is going to cut in six to 12 months so we can get more aggressive. I think that would be a mistake.”

The Fed needs to balance further tightening against financial stability risks that Kaplan says have become dormant but not gone away since the March crisis that led to the collapse of regional banks like Silicon Valley Bank and First Republic.

“What you don’t want to do is raise rates high enough that something else breaks. You don’t want to be in a position at the Fed where you can’t sustain rates at this level and have to turn and make cuts in order to deal with some breakage,” he said.