MNI INTERVIEW: Fed Eyes Hawkish Tilt Despite ‘Quiet’ Recession

The Federal Reserve is likely to maintain a hawkish tone after an expected interest rate hike this week despite an economy that is already weakening substantially, former Dallas Fed adviser Danielle DiMartino Booth told MNI.

Financial markets are hoping for some kind of pause signal from Fed Chair Jerome Powell’s press conference this week but DiMartino Booth believes investors will be disappointed.

“I’m waiting to see how he alters the narrative after he leaves the podium on July 26th, because he goes into his war bunker and says OK now we’ve got September priced out, how do we get September priced back in?” DiMartino Booth, now head of QI research, told MNI’s FedSpeak Podcast. “He’s done it methodically since January 2022 by the way, one month at a time.”

She believes the economy is ill-positioned to absorb further rate increases because many signs already point to recession, including elevated continuing jobless claims and suppressed manufacturing activity.

“We’ll see if he delivers another 25 basis points in September. I’m rooting for him not to because he’s going to slam the economy into recession. That’s happening, one way or the other,” she said, arguing that the recession could be deeper than many are projecting. (MNI INTERVIEW: Fed Will Likely Hike Rates Above 6%-Plosser)

QT IMPERATIVE

DiMartino Booth also believes Powell has intently embraced the higher for longer mantra in large part because the experience of a frozen Treasury market in March 2020 has made him keenly focused on reducing the central bank’s balance sheet to a more manageable size.

“In March of 2020, the U.S. Treasuries quit trading in Asia. You cannot have the risk-free asset of the world quit trading. How do you wrench back the situation where the Fed owns so much of the Treasuries that there wasn’t enough of an outside market to trade?” she said.

That seizure of markets, which led to a decisive Fed response, was cause in part by the central bank’s giant presence in the Treasury market after many years and multiple rounds of QE, she said. “The more he keeps the focus off of the balance sheet, the longer he gets to take his balance sheet down – and that’s his sole focus, that’s all he cares about.”

She thinks Powell would like to get the balance sheet, now at USD8.3 trillion down from a peak of USD 9 trillion, down closer to USD5 trillion.

“Jay Powell determines in March of 2020 the Fed’s footprint is too big and it’s a sovereign national security issue. We have to do everything we can.”

FOREST FOR THE TREES

DiMartino Booth said rising use of credit in addition to heavy fiscal spending are masking consumer and business balance sheets that are already becoming distressed.

“The credit crisis is happening, it’s just happening very slowly,” she said. “The high end consumer, they continue to get these proceeds, and lots of them. It’s really hard to see the forest for the trees.”

DiMartino Booth thinks the recent decline in inflation, which brought headline CPI down to 3% for June and left core prices up 4.8% on the year, will continue because the lagged effects of lower rental leases on the CPI are finally going to start kicking in soon.

“The largest component of CPI is coming down and it’s coming down hard,” she said, adding the flipside will be rising job losses. “Future demand is not there and that means you can only do one thing and it’s to cut your largest expense which is labor."