The Fed remains more focused on inflation than financial stability, says Sebnem Kalemli-Ozcan.
The Federal Reserve is unlikely to “pivot” on interest-rate increases because of recent financial turbulence like the crisis in the UK gilt market, and doing so would threaten its credibility amid high inflation, New York Fed advisor Sebnem Kalemli-Ozcan told MNI.
“I wouldn’t expect any intervention from the Federal Reserve on these things, unless there’s a total financial market collapse like there was in 2008,” said Kalemli-Ozcan, a professor at the University of Maryland and a member of the New York Fed’s Economic Advisory Panel. “Without that, I think they are not going to do anything – they’re going to stay in their inflation fighting mood, and hiking rates, because that’s their job.”
Stubborn inflation could force the Fed to hike beyond the 4.6% projection from the September Summary of Economic Projections, she said, with the federal funds rate potentially peaking at 5% or higher.
“If (core) inflation comes down quickly to 5, and then the interest rate being 5 or 5.2, that’s realistic,” Kalemli-Ozcan said. “Could it go more than 5, 5.5%, it’s possible but I don’t think it’s going to go much higher than that because inflation is going to come down.”
CREDIBILITY AT STAKE
The Fed has hiked 300 basis points since March to a 3% to 3.25% range and it's expected to make a fourth straight outsized 75bp move in November. That's one of the most aggressive cycles in the central bank's history, and she said where the Fed goes from here also depends on how fast supply chain problems are fixed.
“There’s a supply chain and a Covid element to this, which won’t respond to policy. If supply chain pressures ease we might get a soft landing. If not it will take longer,” she said. Atlanta Fed research director David Altig and St. Louis Fed economist Mark Wright recently told MNI it's too soon to say whether price pressures have peaked.
Indeed, Kalemli-Ozcan says the Fed would "completely mess up their policy credibility" by weakening the inflation fight to tackle market disruptions.
“Markets keep trying to say they can’t take this anymore and they are going to pivot," she said. Policy makers “are watching what’s going on internationally but their mandate is price stability and maximum employment.”
EXPECTATIONS IN RIGHT PLACE
It remains unclear whether inflation has peaked, making it even harder for the Fed to ease up and boost the odds of a soft landing, said Kalemli-Ozcan. “I hope inflation has peaked and next time the data is out it’s turning around and the Fed is able to pause. But it’s very difficult to tell," she said.
“In the absence of any other supply shock – I think it is not going to be that hard a landing,” she said. “That’s because expectations are in the right place. When you talk about a hard landing you’re talking about a recession with still high inflation.”
Others have told MNI the Fed's delayed response to rapid inflation puts it back in a historical pattern of hiking and generating a recession afterwards.